What Is a 401(k)? How It Works and If You Should Get One

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According to data from Empower, a financial services company, about 70% of Americans contribute to an employer retirement plan. Many of these plans are company-sponsored 401(k)s, with median balances ranging from less than $30,000 for workers in their 20s to nearly $250,000 for workers in their 50s.

The decline in private pension plans in recent decades has made 401(k) plans the best and often only option for U.S. workers who want to build a retirement fund through their employers. 401(k) plans offer tax-deferred savings and help build your nest egg in a hurry thanks to matching employer contributions.

Here’s more on exactly what a 401(k) is, how the account works and certain benefits and limits.

401(k) Definition and Overview

A 401(k) is a retirement account offered by employers. Workers who sign up for the plans agree to have part of their earnings deducted from their paychecks and put into the 401(k). The deductions are pretax, meaning they come out of the paycheck before taxes are deducted. Pretax deductions lower an employee’s taxable income, meaning you’ll pay less in taxes that year.

401(k) retirement plans also have benefits for employers — mainly as a way of competing for the best workers. Employers also can deduct contributions from their federal income taxes.

Here are some other important things to know:

• 401(k) plan sponsors offer various investment options, including stocks, bonds and mutual funds.
• Employees decide which investments they want and allocate funds toward those investments.
• Employees don’t pay taxes on contributions or interest until withdrawal.
• Employees can contribute to both a 401(k) and an individual retirement account in the same year.

How Does a 401(k) Work?

Employers typically act as plan sponsors for 401(k)s and hire third-party administrators to oversee the accounts. If your employer offers a 401(k) plan, it tells you when you can enroll. In some cases, you can enroll right away, while in others you will have to wait until you finish a probationary period.

When you enroll, you choose how much money you want to contribute and how those funds are invested. There’s a limit to how much you can contribute, however.

Some employers match your contributions, so keep that in mind when you decide how much to contribute. For example, your employer might match your contributions for up to 5% of your income. Matching funds might not be available immediately due to “vesting,” which requires waiting a certain period before the matching funds are yours.

If you get matching contributions, you should aim to contribute up to the limit if possible because the employer match equals free money in your account.

How Does a 401(k) Match Work?

Let’s say your employer offers a 50% partial match on employee contributions up to 7% of your salary. This means that if you decide to contribute 7% of your salary to the 401(k) plan, your employer will contribute an additional 3.5% of your salary (50% of what you’re putting in).

If you decide to contribute less, so will your employer. So if you put in 5% of your salary, they will contribute 2.5%. If you decide to contribute more than the maximum match amount — say, 10% — they will still only contribute 3.5% since that’s their max.

Here’s a table breaking it down further, with a few different examples:

Benefits of a 401(k) Plan

Contributing to a 401(k) offers a range of financial benefits:

• Tax-deferred growth or tax-free withdrawals with a Roth 401(k)
• Higher contribution limits compared to IRAs
• Potential for compounding returns over time
• Employer matching contributions provide free retirement money
• Automatic paycheck deductions make saving consistent and hassle-free

Types of 401(k) Plans

Employers can offer several types of 401(k) plans, including the following:

• Traditional 401(k) plans: With traditional 401(k) plans, employers can make contributions to all participants, match employee contributions, or both. They also can use a vesting schedule and must pass an IRS test to ensure they’re not favoring high earners.
• Safe harbor 401(k) plans: With these plans, employer contributions are vested right away. In other words, once your employer contributes funds, those funds are yours.
• SIMPLE 401(k) plans: These are 401(k) plans for small businesses that don’t have to pass the IRS test for traditional 401(k) plans. Employer contributions are vested immediately.
• Roth 401(k) plans: Roth 401(k) plans allow employees to contribute on an after-tax basis. With a Roth 401(k), you don’t have to worry about paying taxes when it’s time to withdraw funds from the account.

How To Enroll in a 401(k) Plan

Getting started with a 401(k) is straightforward, but there are a few steps to follow:

• Check your eligibility: Some employers may require you to meet certain criteria, such as completing a waiting period or being a minimum age before you can enroll.
• Sign up through your employer: Most companies provide enrollment instructions, often through HR or an online benefits portal.
• Choose your contribution amount: Decide how much of your paycheck to set aside for your 401(k), keeping in mind annual contribution limits and any employer match.
• Select your investments: Review the plan’s investment options and choose a mix that aligns with your risk tolerance and retirement goals.

If you’re unsure about any step, reach out to your HR department or plan administrator for guidance.

401(k) Contribution Limits for 2025

There is a limit to how much you can contribute in a given year. In 2025, the contribution limit for employees who participate in traditional 401(k) plans is $23,500, up from $23,000 in 2024, according to the IRS.

Once the employee’s 2025 income reaches $350,000, the employee and employer can no longer contribute to the 401(k) account.

There are also maximums as to how much can be contributed to a 401(k) by both the employer and employee. In 2025, the maximum for overall contributions is the lesser of the employee’s annual compensation or $70,000, up from $69,000 in 2024.

What Is a 401(k) Catch-Up Contribution?

When you reach a certain age, the IRS allows you to make “catch-up” contributions to your (401)k, helping you increase your savings as you approach retirement.

In 2025, the catch-up contribution for employees 50 and older is $7,500 for traditional 401(k)s, meaning you can contribute up to $30,500 for the full year if you meet the age requirements.

For employees aged 50 and older participating in SIMPLE IRA plans, the 2025 catch-up contribution limit is $3,500.

401(k) vs. Other Retirement Accounts

When planning for retirement, understanding how a 401(k) compares to other accounts, like IRAs, can help you make the most of your savings strategy:

• Contribution limits: A 401(k) allows for significantly higher annual contributions than traditional or Roth IRAs, giving you more room to save.
• Tax benefits: Both 401(k)s and IRAs offer tax advantages, but they work differently. Traditional 401(k)s provide tax-deferred growth, while Roth IRAs offer tax-free withdrawals in retirement.
• Investment options: IRAs often provide more flexibility in choosing investments, while 401(k)s are limited to the options selected by your employer’s plan.

Combining a 401(k) with other accounts can maximize your benefits. For instance, contributing to a Roth IRA alongside your 401(k) lets you balance tax-deferred and tax-free savings, while an IRA can complement your 401(k) with broader investment choices.

Final Takeaway: Should You Open a 401(k)?

A 401(k) plan is a retirement savings option that enables you to contribute a portion of your income to an account. Some employers will match a portion of your contribution. In the long term, a 401(k) plan allows you to build a substantial nest egg over a period of time. Although there are limits on contributions and access to funds, a 401(k) plan offers flexibility and growth potential.

If you have access to a 401(k), it’s generally a good idea to take advantage of it, especially if your employer will match some contributions. Not only is the match free money you’d be leaving on the table otherwise, but you also reap the advantages of contributing pre-tax money to a retirement account. Plus, you can still contribute to an IRA or Roth IRA separately.

The only time you may want to pass on contributing to a 401(k) is if you can’t afford to do so. Also, if you’re nearing retirement and expecting to be in a high tax bracket after you retire, you may want to contribute more to a Roth account so you have some tax-free income coming your way later.

Cynthia Bowman, Rudri Patel and Vance Cariaga contributed to the reporting for this article.

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