What is a 401(k) and How Does It Work?
A 401(k) is an employer-sponsored retirement savings plan that allows employees to save and invest a portion of their paycheck before taxes are taken out. Named after Section 401(k) of the Internal Revenue Code, it is one of the most popular ways Americans save for retirement.
How a 401(k) Works
You contribute a percentage of your salary to your 401(k) account through automatic payroll deductions. Contributions are typically made pre-tax (Traditional 401k), reducing your taxable income now, or after-tax (Roth 401k), allowing tax-free withdrawals in retirement. Many employers offer matching contributions, essentially giving you free money for retirement.
Your contributions are invested in a selection of mutual funds, index funds, target-date funds, and sometimes company stock. The investments grow tax-deferred (Traditional) or tax-free (Roth) until you withdraw them in retirement, typically after age 59½.
2026 Contribution Limits
| Category | 2026 Limit | Notes |
|---|---|---|
| Employee Deferral (Under 50) | $24,500 | Up from $23,500 in 2025 |
| Catch-Up (Age 50+) | $8,000 | Total: $32,500 |
| Super Catch-Up (Age 60-63) | $11,250 | Total: $35,750 (SECURE 2.0) |
| Total Annual Additions (415c) | $72,000 | Employee + employer combined |
| Compensation Cap | $350,000 | Maximum salary considered |
Key Benefits of a 401(k)
Tax Advantages
Traditional: tax-deferred growth, reduce taxable income now. Roth: tax-free withdrawals in retirement.
Employer Match
Many employers match 3-6% of salary. Always contribute enough to get the full match - it is a 100% return on your money.
Higher Limits Than IRAs
401(k) limit of $24,500 is 3.5x the $7,000 IRA limit, allowing you to save significantly more.
Creditor Protection
ERISA provides strong federal creditor protection for 401(k) assets, shielding your retirement from bankruptcy.
Traditional vs Roth 401(k)
| Feature | Traditional 401(k) | Roth 401(k) |
|---|---|---|
| Contributions | Pre-tax (reduces taxable income) | After-tax (no tax break now) |
| Growth | Tax-deferred | Tax-free |
| Withdrawals | Taxed as ordinary income | Tax-free if qualified |
| Best For | Higher tax bracket now | Lower tax bracket now |
Frequently Asked Questions
Penalty-free withdrawals begin at age 59½. The Rule of 55 allows penalty-free access if you leave your employer at 55+. Required Minimum Distributions (RMDs) start at age 73.
You can leave it with your former employer (if over $7,000), roll it to a new employer plan, roll it to an IRA, or cash out (subject to taxes and penalties if under 59½).
Yes, but the total employee contribution across ALL 401(k) plans cannot exceed $24,500 for 2026. You can have accounts at multiple former employers plus your current employer.
An employer match is when your employer contributes to your 401(k) based on your own contributions. Common formulas include 50% match on the first 6% of salary, or dollar-for-dollar match up to 3-4%. This is essentially free money for retirement.