What Is a 401(k), and How Does It Work?

A 401(k) is an employer-sponsored retirement savings plan that lets you invest a portion of your paycheck before taxes. The money grows tax-deferred until you withdraw it in retirement. Some employers also offer a Roth 401(k), which uses after-tax contributions but allows for tax-free withdrawals later.

Is My Employer Offering a Match?

Employer matching is free money. If your company offers to match a percentage of your contributions, find out the details. For example, a common match is 50% of your contributions up to 6% of your salary. Not contributing enough to get the full match means leaving money on the table.

What Are the Investment Options?

401(k) plans offer different investment choices, typically mutual funds that include stocks, bonds, and target-date funds. Look at the list of available funds and ask:

• What are the risk levels?

• What are the historical returns?

• How do they align with my retirement timeline and risk tolerance?

What Are the Fees?

High fees can eat into your savings over time. Ask about:

• Expense ratios for investment funds

• Administrative fees

• Any hidden charges

Even a 1% fee difference can significantly impact your balance over decades.

When Can I Withdraw My Money?

Standard 401(k) rules allow penalty-free withdrawals at age 59½. Taking money out early usually results in a 10% penalty plus income tax. However, exceptions exist for certain situations like disability or significant financial hardship.

What Happens If I Leave My Job?

Your 401(k) doesn’t disappear if you change jobs. You can:

• Leave it with your old employer

• Roll it over into a new employer’s 401(k)

• Move it into an IRA

• Cash it out (not recommended due to penalties and taxes)

Ask your HR department or plan administrator how to handle your account when you leave.

Should I Choose a Traditional or Roth 401(k)?

This depends on your current and expected future tax bracket. A traditional 401(k) gives a tax break now, while a Roth 401(k) gives you tax-free income later. Younger workers often benefit more from Roth accounts, while those closer to retirement might favor traditional contributions.

How Much Should I Contribute?

Start by contributing enough to get your employer’s full match. If you can afford to, increase your contributions over time. The 2025 limit for employee contributions is $23,000 (or $30,500 if you’re over 50, with the catch-up provision). The more you save early, the more time compound interest has to grow your money.