A 401k is a retirement savings account offered through your employer. You contribute pre-tax money, it grows tax-deferred, and you pay taxes when you withdraw in retirement.
How it works
- You elect a contribution percentage (e.g., 6% of your salary)
- That money comes out of your paycheck before taxes — so you pay less income tax now
- You invest it in funds you choose (typically index funds, target-date funds, bonds)
- It grows untaxed until you withdraw
- In retirement, withdrawals are taxed as ordinary income
Contribution limits (2025)
| Type | Limit |
|---|---|
| Employee contribution (under 50) | $23,500 |
| Employee contribution (50+) | $31,000 (catch-up contributions) |
| Total including employer (under 50) | $70,000 |
Most people contribute well under the max. Even 6–10% of salary is a solid start.
Employer matching
Most employers match a portion of your contributions. Common structures:
- 100% match up to 3% — contribute 3%, get 3% free
- 50% match up to 6% — contribute 6%, get 3% free
- Dollar-for-dollar match up to 4%
Always contribute at least enough to get the full employer match. If your employer matches 4% and you only put in 2%, you’re leaving half the match unclaimed — that’s a 50–100% instant return before any market movement.
Vesting schedules
Employer contributions often vest over time — you only keep them if you stay long enough:
- Immediate vesting: you keep all employer contributions from day one
- Cliff vesting: you get 100% after 2–4 years, nothing before that
- Graded vesting: your percentage increases each year (20% after year 1, 40% after year 2, etc.)
Check your plan documents before leaving a job.
Traditional 401k vs Roth 401k
| Traditional | Roth | |
|---|---|---|
| Contributions | Pre-tax | After-tax |
| Growth | Tax-deferred | Tax-free |
| Withdrawals in retirement | Taxed as income | Tax-free |
| Best if | You expect lower tax rate in retirement | You expect higher tax rate in retirement |
If your employer offers a Roth 401k and you’re early in your career (lower income now), Roth is usually the better pick.
Early withdrawal penalty
Withdrawing before age 59½ triggers a 10% penalty plus income taxes on the full amount. Avoid it. Some exceptions exist — but a first home purchase is not one of them for 401k accounts (that exception is IRA-only).
When you leave a job
- Roll it to your new employer’s 401k — simplest option
- Roll it to an IRA — more investment choices, same tax treatment
- Leave it where it is — fine if the plan has good, low-cost funds
- Cash it out — almost never worth it once you factor in taxes and the 10% penalty
Getting started
Contribute at least enough to get your full employer match, then increase contributions as your income grows. Choose low-cost index funds. Don’t touch it until retirement. Tax-deferred compounding over 30–40 years is what actually builds retirement wealth — the account just gets out of the way.