What is a 401(k)?
A 401(k) is a tax-advantaged retirement savings account offered by employers in the United States. The name comes from the section of the Internal Revenue Code that governs it — §401(k). When you contribute to a 401(k), your money goes into individual investment accounts that you control, growing over time until you withdraw it in retirement.
Unlike a traditional pension (defined benefit plan), a 401(k) is a defined contribution plan — meaning the outcome depends on how much you contribute and how your investments perform. The employer doesn't guarantee a specific benefit at retirement; you accumulate whatever you save and invest.
401(k) plans are offered by for-profit employers. Public school teachers and nonprofit employees typically use a similar plan called a 403(b). Government employees often have a 457(b) plan. Self-employed individuals can use a Solo 401(k), SEP IRA, or SIMPLE IRA instead.
How contributions work
You contribute to a 401(k) through automatic payroll deductions — a percentage of each paycheck is transferred to your retirement account before or after taxes, depending on whether you choose traditional or Roth contributions.
Traditional 401(k) (pre-tax)
Traditional contributions reduce your taxable income today. If you earn $80,000 and contribute $10,000 to a traditional 401(k), you only pay income tax on $70,000 this year. Your contributions and any investment gains grow tax-deferred — meaning no taxes while the money is in the account. You pay income taxes when you withdraw the money in retirement.
Roth 401(k) (after-tax)
Roth contributions are made with after-tax dollars — you don't get a tax break today. However, qualified withdrawals in retirement are completely tax-free, including all investment gains. Both traditional and Roth contributions count toward the same annual limit. Unlike a Roth IRA, there are no income limits for Roth 401(k) contributions — anyone can choose Roth regardless of income.
If you expect to be in a higher tax bracket in retirement than you are now, Roth is better. If you expect to be in a lower bracket in retirement, traditional is better. When uncertain, splitting contributions between both provides tax diversification.
Employer match: the most valuable benefit
Many employers contribute additional money to your 401(k) based on how much you contribute — this is called an employer match. It is essentially free money and is the single most powerful reason to participate in a 401(k).
Common matching formulas
| Match Formula | You Contribute | Employer Adds | Total Contribution |
|---|---|---|---|
| 100% match, first 3% | 3% of salary | 3% of salary | 6% of salary |
| 50% match, first 6% | 6% of salary | 3% of salary | 9% of salary |
| 100% match, first 4%; 50% on next 2% | 6% of salary | 5% of salary | 11% of salary |
| No match offered | Any amount | $0 | Your contribution only |
If your employer matches contributions and you're not contributing at least enough to get the full match, you're giving up part of your compensation. A 50% match is an immediate 50% return — no investment can reliably beat that. Make getting the full match your first financial priority.
Employer match contributions count toward the total annual additions limit ($72,000 in 2026) but not toward the employee contribution limit ($24,500). Employer contributions are also subject to the IRS compensation limit of $360,000.
Vesting schedules explained
Your own contributions are always 100% yours immediately — you can take them with you if you leave the company. Employer match contributions, however, may be subject to a vesting schedule — meaning you don't own them outright until you've worked there long enough.
Types of vesting schedules
- Immediate vesting: Employer contributions are 100% yours from day one. The most employee-friendly option.
- Cliff vesting: You own 0% until a specific year, then 100% at once. Example: 0% for 3 years, then 100%. If you leave before 3 years, you forfeit all employer contributions.
- Graded vesting: Ownership increases gradually. Example: 20% per year over 5 years. If you leave after 2 years, you keep 40% of employer contributions.
If you're 6 months from being fully vested, leaving early could cost you thousands of dollars in employer contributions. Review your Summary Plan Description (SPD) to understand your vesting terms.
2026 contribution limits
The employee contribution limit is the most you can personally contribute from your paycheck: $24,500 in 2026. This is up from $23,500 in 2025.
The total annual additions limit ($72,000) includes all contributions: employee deferrals, employer match, and any after-tax contributions. This is the combined ceiling.
Workers 50 or older can contribute an extra $8,000 as a catch-up. A new SECURE 2.0 provision allows workers aged 60–63 a larger super catch-up of $11,250 — replacing the standard catch-up for those years.
Starting January 1, 2026, employees whose prior-year FICA wages exceeded $150,000 must make their catch-up contributions as Roth (after-tax) — not pre-tax. This is a SECURE 2.0 rule that applies regardless of your preference. If you earned more than $150,000 in 2025, your 2026 catch-up contributions will automatically be Roth.
What you can invest in
Your 401(k) plan offers a menu of investment options chosen by your employer. Unlike an IRA (where you can invest in almost anything), 401(k) options are limited to what the plan administrator selects. Typical options include:
- Index funds — low-cost funds that track a market index like the S&P 500 (recommended for most investors)
- Actively managed mutual funds — funds run by professional managers (typically higher fees)
- Target-date funds — automatically shift from aggressive (stocks) to conservative (bonds) as your retirement year approaches
- Company stock — some employers offer their own stock (generally risky to hold too much)
- Stable value funds / money market funds — very low risk, very low return
The single biggest predictor of investment returns you can control is cost. Look for funds with expense ratios below 0.20%. A 1% expense ratio vs 0.05% ratio on a $500,000 account costs you roughly $4,750/year — compounding over decades, the difference is enormous.
Early withdrawal rules and exceptions
Withdrawing money from your 401(k) before age 59½ normally triggers a 10% early withdrawal penalty on top of ordinary income taxes. On a $10,000 withdrawal in the 22% bracket, that's $3,200 in taxes and penalties — keeping only $6,800.
Penalty-free exceptions
The IRS allows several exceptions where you can withdraw early without the 10% penalty (taxes still apply):
- Death or total disability
- Separation from service at age 55 or older (Rule of 55)
- Substantially Equal Periodic Payments (SEPP / Rule 72(t))
- Qualified Domestic Relations Order (divorce settlement)
- Medical expenses exceeding 7.5% of AGI
- Health insurance premiums while unemployed (IRA only, not 401k)
- First-time home purchase (IRA only, not 401k — up to $10,000 lifetime)
- Terminal illness (SECURE 2.0)
- Federally declared disasters (SECURE 2.0)
- Domestic abuse (SECURE 2.0)
401(k) loans
Many 401(k) plans also allow you to borrow from your account — up to 50% of your vested balance or $50,000, whichever is less. You repay the loan (with interest) back to yourself. However, if you leave your job while a loan is outstanding, the entire balance typically becomes due within 90 days — otherwise it's treated as a distribution and taxed accordingly.
When withdrawals are required: RMDs
You can't keep money in a 401(k) forever. The IRS requires you to start taking Required Minimum Distributions (RMDs) starting at age $73. If you're still working for the employer sponsoring the plan, you may be able to delay RMDs until you actually retire.
The RMD amount is calculated by dividing your prior December 31 account balance by an IRS life expectancy factor. Missing an RMD results in a 25% excise tax on the amount not withdrawn — reduced to 10% if corrected within two years.
Note: Under SECURE 2.0, the RMD start age will increase to 75 for those who turn 74 after December 31, 2032. Roth 401(k) accounts are now also exempt from RMDs during the owner's lifetime (starting 2024).
Frequently asked questions
The employee contribution limit is $24,500. Workers 50+ can add a $8,000 catch-up (total $32,500). Workers 60–63 have a higher super catch-up of $11,250 (total $35,750). The combined employee + employer limit is $72,000.
You have four options: (1) Leave it with your former employer's plan — allowed if balance is over $5,000; (2) Roll it over to your new employer's 401(k) plan; (3) Roll it over to a Traditional IRA — most flexible option, no taxes or penalties; (4) Cash it out — not recommended due to taxes and 10% penalty. Rolling to an IRA gives you the widest investment selection and lowest fees.
No. Your Social Security benefit is based on your 35 highest-earning years of FICA wages. Traditional 401(k) contributions don't reduce FICA wages (Social Security tax is still paid on the full amount) — only federal and state income tax liability is reduced. Contributing to a 401(k) does not reduce your future Social Security benefit.
Yes. 401(k) and IRA contribution limits are completely independent. In 2026, you can contribute $24,500 to a 401(k) and up to $7,500 to an IRA in the same year. Note that if you (or your spouse) are covered by a workplace retirement plan, your Traditional IRA deduction may be reduced or eliminated at higher income levels.
The Rule of 55 allows you to withdraw from your 401(k) penalty-free if you leave your job in or after the year you turn 55. This does not apply to IRAs. It only applies to the 401(k) plan at the employer you separated from — not prior employers' plans. It's a useful bridge strategy between early retirement and the standard age-59½ threshold.