What Is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan that lets you contribute a portion of your paycheck before (or after) taxes, with the money growing tax-advantaged until retirement.

The name comes from section 401(k) of the Internal Revenue Code—not particularly exciting, but the tax benefits definitely are.

2026 Contribution Limits

Category	2026 Limit
Employee contributions (under 50)	$23,500
Catch-up contributions (50+)	$7,500
Total if 50+	$31,000
Combined employee + employer limit	$70,000
Combined employee + employer (50+)	$77,500

Pro tip: These limits increase most years with inflation. Check IRS.gov or our [401(k) Calculator](/401k-calculator) for current limits.

How 401(k) Contributions Work

Automatic Payroll Deduction

When you enroll, you choose a percentage or dollar amount to contribute from each paycheck. This happens automatically—you never see the money in your bank account, which makes saving easier.

Pre-Tax Contributions (Traditional 401(k))

With a Traditional 401(k), contributions come out before taxes:

Example with $75,000 salary, $10,000 contribution: - Taxable income becomes: $65,000 - Tax savings at 22% bracket: ~$2,200 - Real "cost" of $10,000 contribution: ~$7,800

You pay taxes when you withdraw in retirement.

After-Tax Contributions (Roth 401(k))

With a Roth 401(k), contributions come from after-tax income:

Same example: - Taxable income stays: $75,000 - No immediate tax benefit - BUT: Withdrawals in retirement are 100% tax-free

Traditional vs. Roth 401(k): Which to Choose?

Factor	Traditional 401(k)	Roth 401(k)
Tax benefit	Now (lower taxable income)	Later (tax-free withdrawals)
Best if tax rate	Higher now than in retirement	Lower now than in retirement
RMDs in retirement	Yes, starting at 73	Yes (can roll to Roth IRA to avoid)
Withdrawal flexibility	Taxed as ordinary income	Tax-free if qualified

General Guidelines:

Choose Traditional 401(k) if: - You're in a high tax bracket now (32%+) - You expect lower income in retirement - You need the immediate tax reduction - You're close to retirement

Choose Roth 401(k) if: - You're in a lower tax bracket now (22% or below) - You expect higher income in retirement - You're young (more years of tax-free growth) - Tax rates may increase in the future

Best strategy for many: Split contributions between both to have tax diversification in retirement.

The Magic of Employer Matching

Free money alert! Employer matching is the best return on investment you'll ever get.

Common Match Formulas:

**Dollar-for-dollar up to X%**
- You contribute 5% → Employer adds 5%
- 100% instant return on your contribution!

**50 cents per dollar up to X%**
- You contribute 6% → Employer adds 3%
- 50% instant return

**Tiered matching**
- 100% match on first 3%, 50% match on next 2%
- You contribute 5% → Employer adds 4%

Always Contribute Enough to Get the Full Match

If your employer matches 50% up to 6%, contributing only 3% leaves money on the table.

Example with $75,000 salary, 50% match up to 6%: - Contributing 3% = $2,250 + $1,125 match = $3,375/year - Contributing 6% = $4,500 + $2,250 match = $6,750/year

That's $3,375/year in free money you'd miss!

Use our [401(k) Calculator](/401k-calculator) to see how matching affects your long-term savings.

Vesting Schedules

Vesting = When you actually "own" employer contributions.

Your contributions are always 100% yours. Employer contributions may have a vesting schedule:

Schedule Type	Example
Immediate vesting	100% yours from day one
Cliff vesting	0% until year 3, then 100%
Graded vesting	20% per year, 100% at year 5

Why it matters: If you leave before being fully vested, you forfeit the unvested employer contributions.

401(k) Investment Options

Unlike IRAs, your 401(k) investment choices are limited to what your employer offers. Typical options include:

Target-Date Funds - Pick the fund matching your retirement year (e.g., "2055 Fund") - Automatically becomes more conservative as you age - Great "set it and forget it" option

Index Funds - Track market indexes (S&P 500, total stock market, bonds) - Very low fees (0.03%-0.20%) - Usually the best choice for most investors

Actively Managed Funds - Fund manager picks investments - Higher fees (0.50%-1.50%) - Rarely outperform index funds long-term

Company Stock - Risky to have too much in one company - Keep below 10% of total portfolio

Recommended Simple Portfolio: - 80% Total Stock Market Index (if young) - 20% Bond Index (increase bonds as you near retirement)

401(k) Fees to Watch

Fees eat into your returns over time.

Types of Fees: 1. Expense ratios - Annual fund fees (0.03% to 1.5%+) 2. Administrative fees - Plan maintenance ($20-100/year typical) 3. Individual service fees - Loan processing, hardship withdrawals

Fee Impact Example:

$500,000 portfolio over 25 years at 7% return:

Expense Ratio	Ending Balance	Fees Paid
0.10%	$2,649,000	$51,000
0.50%	$2,406,000	$294,000
1.00%	$2,124,000	$576,000

That 1% fee costs you $525,000 over 25 years!

Always check expense ratios and choose the lowest-cost options available.

401(k) Loans and Withdrawals

401(k) Loans - Borrow up to 50% of vested balance (max $50,000) - Must repay within 5 years (usually) - If you leave your job, balance due within 60 days - Generally not recommended unless emergency

Early Withdrawals (Before 59½) - 10% penalty PLUS income taxes - Some exceptions: disability, medical expenses, IRS levy - Almost never worth it due to tax hit and lost growth

Hardship Withdrawals - Must demonstrate immediate financial need - Taxes and possibly penalty apply - Should be absolute last resort

What Happens When You Leave Your Job

Option 1: Leave It - If over $7,000 balance, can usually stay - May have higher fees than other options - Easy, but can forget about it

Option 2: Roll Into New Employer's 401(k) - Keeps all retirement money together - No tax consequences if done correctly (direct rollover) - Check new plan's investment options and fees first

Option 3: Roll Into an IRA - More investment choices - Often lower fees - Usually the best option for most people - Use a direct rollover to avoid taxes

Option 4: Cash Out (Don't Do This!) - Taxes + 10% penalty if under 59½ - Could lose 30-40% to taxes - Devastates long-term retirement savings - Seriously, don't do this

401(k) Strategies by Age

20s-30s: Growth Phase - Contribute at least enough for full employer match - Invest aggressively (80-100% stocks) - Increase contribution rate by 1% each year - Consider Roth 401(k) while in lower tax brackets

40s: Acceleration Phase - Aim for max contributions ($23,500) - Review and rebalance annually - Start thinking about Traditional vs. Roth mix - Check if on track for retirement goals

50s: Catch-Up Phase - Add catch-up contributions ($7,500 extra) - Gradually shift to more conservative investments - Plan withdrawal strategy - Consider Roth conversions if beneficial

60s: Transition Phase - Review asset allocation (maybe 40-60% stocks) - Understand RMD rules (starting at 73) - Coordinate with Social Security claiming strategy - Plan for healthcare costs

Maximizing Your 401(k)

Step 1: Get the Full Match Non-negotiable. It's free money.

Step 2: Max Out If Possible $23,500/year = $1,958/month Over 30 years at 7% return = ~$2.3 million

Step 3: Choose Low-Cost Index Funds Save potentially hundreds of thousands in fees.

Step 4: Don't Touch It Leave it alone until retirement. No loans, no early withdrawals.

Step 5: Increase Contributions Annually Bump up 1% each year or with raises until maxed.

The Bottom Line

Your 401(k) is one of the most powerful wealth-building tools available:

**Tax advantages** reduce your tax bill or provide tax-free retirement income
**Employer matching** is free money you can't get anywhere else
**Automatic contributions** make saving effortless
**Compound growth** turns consistent contributions into millions over time

Start with the employer match, increase contributions when possible, choose low-cost index funds, and don't touch it until retirement.

Use our [401(k) Calculator](/401k-calculator) to see how your contributions will grow over time.

---

This content is for educational purposes and not financial advice. Consult a financial professional for personalized guidance.

Calculate Your Retirement Savings