Definition
An employer-sponsored retirement plan that lets workers contribute pre-tax dollars from their paycheck, often with an employer match.
In depth
A 401(k) is an employer-sponsored retirement savings plan named after the section of the US Internal Revenue Code that governs it. Employees contribute a portion of each paycheck before income taxes are withheld — directly reducing their current taxable income — and the invested money grows tax-deferred until retirement withdrawal, when it is taxed as ordinary income.
For 2024, employees can contribute up to $23,000 per year. Those aged 50 or older can contribute an additional $7,500 in "catch-up" contributions, for a total of $30,500. Many employers offer matching contributions — typically 50–100% of employee contributions up to 3–6% of salary. An employer match is an immediate guaranteed return that should almost always be captured in full before directing savings elsewhere.
The Roth 401(k) variant, now available through most employer plans, accepts after-tax contributions. Qualified withdrawals in retirement — including all investment growth — are completely tax-free. For younger workers or those who expect to be in a higher tax bracket in retirement, Roth contributions are often the better choice.
401(k) assets are invested in a menu of mutual funds, index funds, and target-date funds selected by the plan administrator. When changing jobs, you can leave the 401(k) with the former employer, roll it into a new employer's plan, or roll it into an IRA — typically offering the widest investment selection. Early withdrawals before age 59½ trigger a 10% penalty plus ordinary income tax, which can consume 30–40% of the balance withdrawn.
Frequently asked questions
How much should I contribute to my 401(k)?
At minimum, contribute enough to receive the full employer match — those matched dollars represent a guaranteed 50–100% immediate return, which no investment can reliably beat. Beyond the match, maximize contributions up to the annual IRS limit ($23,000 in 2024) if your budget allows. A common planning target is saving 15% of gross income for retirement in total, including employer contributions.
What happens to my 401(k) when I change jobs?
You have four options: leave it with the former employer, roll it into your new employer's plan, roll it into an IRA (most investment flexibility), or cash it out. Never cash out unless facing a genuine financial emergency — you'll pay ordinary income tax plus a 10% early withdrawal penalty, losing 30–40% of the balance immediately and permanently.
Should I contribute to a Traditional or Roth 401(k)?
Traditional reduces your taxable income today; you pay taxes on withdrawals in retirement. Roth uses after-tax dollars now; qualified withdrawals are completely tax-free. Roth is generally better if you're early in your career, in a lower current tax bracket, or expect taxes to be higher in retirement. Traditional is better if you're in a high tax bracket now and expect lower income in retirement. Many financial planners recommend splitting contributions between both.
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