401(k)

A tax-advantaged retirement savings account offered through an employer, often with an employer match.

A 401(k) is an employer-sponsored retirement savings plan that lets employees contribute a portion of their pre-tax (or after-tax, in the case of Roth) salary directly into an investment account. Contributions reduce your taxable income in the year they're made (for traditional contributions), grow tax-deferred, and are taxed as ordinary income when withdrawn in retirement.

The employer match is the most immediate financial benefit of a 401(k). Many employers match employee contributions up to a certain percentage — typically 3-6% of salary. A 100% match on your first 3% of contributions is effectively an instant 100% return on that portion of your savings. Not taking full advantage of the match is one of the most costly compensation mistakes employees make.

The IRS sets annual contribution limits that change most years. For 2025, the employee contribution limit is $23,500 for those under 50, with a $7,500 catch-up contribution allowed for those 50 and older. Employer contributions don't count toward this limit. Total combined contributions (employee + employer) are capped at a higher combined limit.

401(k) plans offer a selection of investment options — typically mutual funds across a range from conservative (money market, bond funds) to aggressive (small-cap equity funds). Index funds with low expense ratios are widely regarded as the most effective choice for most long-term investors. The expense ratio of your fund choices compounds over decades alongside your investment returns.

Traditional vs. Roth 401(k): Which to Choose

Traditional 401(k) contributions are pre-tax — you reduce your taxable income now and pay taxes when you withdraw in retirement. Roth 401(k) contributions are after-tax — you pay taxes now, but withdrawals in retirement are completely tax-free. The right choice depends on whether you expect your tax rate to be higher now or in retirement. Younger, lower-income earners often benefit more from Roth because they're in a lower bracket now. Higher earners who expect a lower tax rate in retirement typically benefit more from traditional. Many financial advisors recommend contributing to both if your plan allows it.

401(k) Employer Matching: How It Works

  • Common match formula: '100% of contributions up to 4% of salary' — you put in 4%, employer adds another 4%, total is 8%.
  • Never contribute less than the match percentage — you're leaving free compensation on the table.
  • Some employers use a partial match: '50% of contributions up to 6%' means a maximum employer contribution of 3% of salary.
  • Matching is subject to vesting schedules — you may need to stay for 2-5 years before employer contributions are fully yours.
  • Some employers offer a profit-sharing contribution in addition to a match — a discretionary amount added to 401(k) accounts based on company performance.

Investment Strategy Inside a 401(k)

Most 401(k) plans offer a limited menu of mutual funds. If your plan offers low-cost index funds (look for expense ratios below 0.20%), prioritize those over actively managed funds. A simple target-date fund (e.g., 'Target Date 2055') automatically adjusts its allocation from growth-oriented to conservative as you approach retirement — a sensible default for people who don't want to manage their own allocation. If your plan's investment options are poor (high fees, no index funds), it's still worth contributing enough to get the match, then directing additional retirement savings to an IRA.

What Happens to Your 401(k) When You Leave

  • Your vested balance is always yours — unvested employer contributions are forfeited if you leave before they vest.
  • You can leave the account with your old employer's plan (if they allow it), roll it over to your new employer's plan, roll it to an IRA, or cash it out.
  • Cashing out triggers income taxes plus a 10% early withdrawal penalty if you're under 59½ — almost always the worst option.
  • Rolling over to an IRA gives you the most investment flexibility and control.
  • Track old 401(k)s — Americans leave behind hundreds of billions in forgotten retirement accounts every year.

Example

An employee earning $75,000 contributes 6% of her salary ($4,500/year) to capture her employer's full 50%-up-to-6% match ($2,250/year). She selects a target-date fund aligned with her expected retirement year and never changes it. Starting at 25, she is projected to retire with approximately $800,000 from this contribution alone — assuming 7% average annual returns — without ever increasing her rate. The employer match alone accounts for roughly $180,000 of that total.