What does "cost basis" represent in relation to 401(k) investments?

The term "cost basis" refers to the original value of an investment, specifically the amount that was paid for the investment when it was initially acquired. In the context of 401(k) investments, the cost basis is critical for determining capital gains or losses for tax purposes when funds are withdrawn or when investments are sold. It represents the initial amount invested without taking into account any market fluctuations or contributions made thereafter.

Understanding cost basis is important for participants in a 401(k) plan since it helps them comprehend how much profit they may be subject to tax on should they choose to withdraw or distribute those funds in the future. It’s important to distinguish this from other financial terms; for example, the current market value relates to the present worth of the investment and may fluctuate based on market conditions, while contributions made to the account represent the money added to the 401(k) plan but do not reflect the value or performance of the investment itself. Withdrawals during retirement, on the other hand, do not influence the cost basis but instead represent the realized returns on the investment made with the cost basis in mind.