What Is a 401(k)?
A 401(k) is an employer-sponsored retirement savings plan, named after the section of the U.S. tax code that created it. It lets employees set aside a portion of each paycheck for retirement in a tax-advantaged account, and it is the primary way most American workers save for retirement. Money goes in automatically through payroll, so saving becomes a habit you barely have to think about.
How a 401(k) Works
You decide what percentage of your salary to contribute, and your employer deducts it from each paycheck and deposits it into your account before you ever see the money. You then choose how to invest those funds from a menu the plan offers — commonly mutual funds or target-date funds. The investments grow over time, and the tax advantages mean more of your money stays invested and compounding.
The Employer Match
Many employers match part of what you contribute, which is effectively free money added to your retirement. A common formula is a 50% match on the first 6% of your salary that you contribute, though the details vary by employer. Because the match is part of your compensation, financial guidance generally suggests contributing at least enough to capture the full match before prioritizing other savings.
Traditional vs. Roth 401(k)
Many plans offer two flavors. A traditional 401(k) is funded with pre-tax dollars, lowering your taxable income now, with withdrawals taxed as ordinary income in retirement. A Roth 401(k) is funded with after-tax dollars, so qualified withdrawals later — including the growth — are tax-free. The choice hinges largely on whether you expect your tax rate to be higher today or in retirement.
Vesting: When the Match Is Truly Yours
The money you contribute is always 100% yours. Employer-matched money, however, may be subject to a vesting schedule — you might need to stay with the company for a set number of years before the match fully belongs to you. If you leave before you are fully vested, you can forfeit the unvested portion of the employer's contributions, so it is worth knowing your plan's schedule.
Contribution Limits and Withdrawal Rules
The IRS caps how much you can contribute to a 401(k) each year and allows an additional "catch-up" contribution for those age 50 and older. These limits are adjusted for inflation most years, so always confirm the current figures at IRS.gov rather than relying on a number that may be out of date. Withdrawals generally cannot begin until age 59½; taking money out earlier usually triggers income tax plus a 10% early-withdrawal penalty, with limited exceptions. Traditional 401(k)s also require minimum distributions starting at the age set by current IRS rules.
A 401(k) is one piece of a retirement plan — compare it with an IRA and a Roth IRA, and project your savings with our retirement calculator.
Frequently Asked Questions
A widely cited starting point is to contribute at least enough to receive your full employer match, since that match is free money, and then work toward saving roughly 10-15% of your income (including the match) over time. The right number depends on your income, expenses, and goals, so treat this as general education rather than personal financial advice.
Your vested balance stays yours. You typically have four options: leave it in the old employer's plan, roll it into your new employer's 401(k), roll it into an IRA, or cash it out (which usually means taxes and a penalty if you are under 59½). Rolling it over keeps the money growing tax-advantaged.
A 401(k) is offered through an employer, often includes a match, and has higher contribution limits. An IRA is an individual account you open yourself, with lower limits but usually a much wider range of investment choices. Many people use both, and money can be rolled from a 401(k) into an IRA.