What is a 401(k)?

What is a 401(k)?

A 401(k) is an employer-sponsored, defined-contribution retirement account, named for a section of the US tax code from 1978. You send part of your paycheck into your own investments, and the tax break is the reward.

It is a defined-contribution plan, the opposite of a pension. A pension promised a set check for life. The 401(k) replaced it, and now the responsibility sits on you. What you save and how you invest decides your retirement.

How do you start a 401(k)?

Ask your employer if a 401(k) is available. If it is, you sign up through payroll and pick a contribution percentage. Many companies now auto-enroll you, so check your paycheck and opt out only if you mean to.

Set your rate high enough to get the full employer match from day one. Aim to save 10-15% of pay in your 20s and climb toward 25-35% by your early 40s, raising your contribution yearly. Small steps compound into real money.

How do the traditional and Roth 401(k) work?

A traditional 401(k) takes contributions from pre-tax pay. That lowers your taxable income today, and the money grows tax-deferred. You pay income tax on withdrawals later, usually in retirement. The savings show up immediately in your take-home pay.

A Roth 401(k) works in reverse: you contribute after-tax dollars and owe nothing on qualified withdrawals later. Unlike a Roth IRA, it has no income limit. Choose traditional for a lower tax rate now, Roth for a higher one, and you can convert balances to Roth.

How does the employer match work?

Many employers match part of what you put in. The typical employer match is 50 cents per dollar up to 6% of pay. That is free money and an instant return on your contribution.

Vesting decides ownership too. Your contributions are always yours, but the employer match may not vest fully until you stay a set number of years. Quit early and you can leave part of that free money behind, so know your plan's vesting schedule before you move on.

What are the 401(k) contribution limits?

For 2026, the IRS contribution limit on your own money is $24,500. Add the catch-up for those 50 and older and it becomes $32,500. Anyone aged 60 to 63 gets an even higher catch-up of $11,250. Earn over $150,000 and SECURE 2.0 forces that catch-up into Roth after-tax dollars.

Employer money counts toward a separate ceiling. The combined employee and employer total for 2026 is $72,000, or $80,000 with catch-up. Above the cap, some plans allow after-tax contributions that make a mega backdoor Roth possible. These numbers change with inflation, so check the IRS figure each year.

When can you withdraw from a 401(k)?

Withdraw before age 59 and a half and you owe income tax plus a 10% early-withdrawal penalty. Certain exceptions waive it: hardship, 72(t) substantially equal payments, permanent disability, and death. Leave at 55 or later and the rule of 55 lifts the penalty too.

Traditional 401(k)s also carry required minimum distributions, or RMDs, starting at age 73, and Roth 401(k)s skip them while you live. SECURE 2.0 also waives the early penalty for domestic abuse, disasters, emergencies up to $1,000 a year, and the birth or adoption of a child.

What are the main types of 401(k) plans?

The traditional 401(k) is not the only kind. Nearly every plan must pass nondiscrimination tests, the ADP and ACP, proving deferrals and matches do not favor highly paid employees. A safe harbor plan meets the bar with a set employer contribution and full vesting, which exempts it.

A SIMPLE 401(k) gives small businesses a low-paperwork version with simpler rules and lower limits. If you are self-employed, a solo 401(k) lets you contribute as both employee and employer. Nonprofits and public employers offer cousins like the 403(b) and 457(b).

What happens to a 401(k) when you leave a job?

You have four options, and each keeps the tax break. Roll it into an IRA, move it to your new employer's plan, leave it, or cash out. Cashing out is taxable and usually the worst choice.

The real mistake is doing nothing. Millions abandon old accounts and the money sits forgotten. Roll directly from trustee to trustee so cash never touches your hands and you dodge the 60-day window, which turns a late redeposit into a taxable withdrawal.

Can you borrow from a 401(k)?

Many plans let you borrow from your 401(k), typically up to half your balance capped at $50,000. You repay yourself with interest, and the loan is usually due within five years. The money keeps growing while you owe it.

A 401(k) loan is not free. Lose your job and the balance can accelerate to a taxable distribution, and you owe penalty plus income tax if you cannot repay. Treat borrowing as a last resort, not a spending tool.

How do you invest a 401(k)?

Most plans offer a menu of funds, and the default is often a target-date fund that turns more conservative as you near retirement. You can also pick low-cost stock and bond index funds. Fees eat returns for decades.

A 401(k) differs from a brokerage account, which lets you buy almost any stock or fund but is taxable, with no contribution limit or match. The 401(k) trades that freedom for the tax break.