A 401(k) is an employer-sponsored retirement savings option that allows you to contribute money from your paycheck into an investment account.
Contributions to a traditional 401(k) are made pre-tax, which can lower your taxable income. Contributions to a Roth 401(k) are made with after-tax dollars, allowing for tax-free withdrawals in retirement.
Many employers offer matching contributions up to a certain percentage of your salary, which can provide a significant savings boost.
A 401(k) is a type of employer-sponsored retirement savings plan that offers significant tax advantages. When you participate in a 401(k), you decide how much of each paycheck to contribute, and your employer automatically deducts this amount and invests it according to your choices. Many employers also match a percentage of your contributions, essentially providing free money toward your retirement.
Your 401(k) contributions receive favorable tax treatment. Depending on which type you choose, you'll either get tax benefits when you contribute or when you withdraw the money in retirement.
Let’s go deeper into how a 401(k) works and how to make the most of this employer-sponsored benefit
The two primary 401(k) plan options are a traditional 401(k) and a Roth 401(k). Here's how they compare:
|
Traditional 401(k) |
Roth 401(k) |
2025 contribution limits |
Up to $23,500. People age 50 and older can contribute an extra $7,500 as a catch-up contribution. People ages 60 to 63 have a catch-up contribution of $11,250. |
|
Tax treatment of contributions |
Contributions are made pre-tax. |
Contributions are made after-tax. Any employer match must go into a pre-tax account. |
Tax treatment of withdrawals |
Distributions in retirement are taxed as ordinary income. |
No taxes on qualified distributions. |
Withdrawal rules |
Withdrawals are taxed. Distributions before age 59 ½ may have penalties unless you meet an IRS exception. |
Distributions and earnings are not taxed as long as the account has been held for at least five years and the distribution is on or after 59 ½ or due to disability or death. |
Each type of 401(k) has distinct tax advantages.
Many employers offer both options, allowing you to diversify your tax strategy across both account types.
Your 401(k) contributions receive favorable tax treatment. Depending on which type you choose, you'll either get tax benefits when you contribute or when you withdraw the money in retirement.
Your employer determines whether to offer a 401(k) as well as a contribution match. Common matching arrangements include:
Consider this example: You earn $5,000 a month and your employer offers a 50% match up to 6% of your wages. Contributing $300 monthly (6%) triggers a $150 employer match, totaling $450 in monthly retirement savings.
Starting in 2025, the SECURE 2.0 Act requires most employers to automatically enroll eligible employees into existing 401(k) and 403(b) plans at 3-10% contribution rates, increasing annually to a maximum of 15%. You maintain control over your investment selections from your plan's available options.
Your 401(k) will offer different investment options, typically including:
You can decide how much of your 401(k) balance you want to invest in different funds or allow your plan to automatically enroll you. Regardless of what you choose, you’ll be able to change your investment allocations and rebalance your portfolio. If you’re unsure how to invest your contributions, a financial professional can provide education and guidance on asset allocation strategies.
It's in your best interest to start saving as soon as possible. The sooner you start contributing to a 401(k), the more opportunity for compound growth. Compound growth allows you to grow your investment on both the money you saved and the growth you’ve already achieved. Over time, your compound earnings could be larger than the contributions you made to your 401(k).
How much you contribute to a 401(k) depends on your personal financial situation. To receive the most benefits, the general recommendation is to set your 401(k) contributions to ensure you receive at least the full employer match.
There is a cap on how much you can contribute to your 401(k). To account for inflation, the maximum amount an employer and employee can contribute is adjusted yearly.
The 2025 contribution limits are:
Beyond the employer match, aim to maximize your contributions when possible.
Typically, you can withdraw from a 401(k) without penalties when you’re 59 ½ years old and have separated from your employer. Generally, required minimum distributions (RMDs) from traditional 401(k)s begin at age 73, or April 1 of the year after you turn 73, whichever is later. For those born in 1959 or later, this age will increase to 75 in 2033. The amount you’ll be required to withdraw will depend on your age and the balance in your account.
You can borrow money from your 401(k), but early withdrawal before age 59 ½ may lead to a 10% penalty fee, federal income tax, state income tax and other related taxes. However, the IRS does allow for certain exceptions regarding financial hardship. These may include:
Note that restrictions may apply, so be sure to consult with a financial and tax professional to fully understand the rules and tax ramifications. Read more about 401(k) and IRA withdrawal rules.
You have four main options for your 401(k) whenever you change jobs. These include:
A few other considerations as you decide which option is right for you:
Learn more about your 401(k) rollover options.
Start by contributing enough to capture your full employer match, if one is offered. From there, consider increasing your contributions over time as your budget allows, working toward the annual maximum when possible.
Yes, but early withdrawals before age 59½ may trigger taxes and penalties. Some plans allow loans or hardship withdrawals, but those should generally be a last resort.
You can usually leave the money in your old employer’s plan, roll it into your new employer’s plan, or move it into an IRA. Each option has benefits depending on fees, investment choices, and convenience.
Understanding the differences between IRAs and 401(k)s—from contributions and taxes to withdrawals—can help you determine which account best aligns with your financial goals.
Whether you prefer investing on your own or want professional guidance, we have an option to fit your needs.
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