What Is a 401(k)? How It Works and If You Should Get One
Written by
Melinda Sineriz
Edited by
Nupur Gambhir, CFHC™
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A 401(k) is an employer-sponsored retirement savings account that lets you set aside a portion of each paycheck before taxes are taken out. Your contributions grow tax-deferred, meaning you don’t pay taxes on them until you withdraw the money in retirement. Many employers also match a portion of what you contribute — effectively adding free money to your account.
About 70% of Americans contribute to an employer retirement plan, according to Empower. With the decline of private pension plans, the 401(k) has become the primary way most U.S. workers build retirement savings through their employer.
How Does a 401(k) Work?
When you enroll in a 401(k), you choose how much of your paycheck to contribute and how to invest those funds. Contributions are deducted automatically before taxes, which lowers your taxable income for the year.
Your employer acts as the plan sponsor and typically hires a third-party administrator to manage the accounts. Investment options usually include a mix of stocks, bonds, and mutual funds — you decide how to allocate your money among them.
You won’t pay taxes on contributions or investment growth until you start making withdrawals, typically in retirement.
How Does a 401(k) Employer Match Work?
Many employers match a percentage of your contributions up to a certain limit — and this is money you should always try to capture in full. Here’s how a match works in practice:
| Employer Match | 50% up to 7% of salary | 100% up to 4% of salary |
|---|---|---|
| Employee Salary | $50,000 | $50,000 |
| Employee Contribution | 7% | 4% |
| Employee Contributes Yearly | $3,500 | $2,000 |
| Employer Contributes Yearly | $1,750 | $2,000 |
| Total Annual Contribution | $5,250 | $4,000 |
If you contribute less than the match threshold, your employer contributes less too. Contributing at least enough to capture the full match is one of the most impactful financial moves you can make.
One thing to be aware of: employer matching funds may not be immediately yours. Many plans use a vesting schedule, which requires you to stay with the company for a set period before the matched funds fully belong to you.
What Are the 401(k) Contribution Limits for 2025?
The IRS sets annual limits on how much you can contribute:
- Employee contribution limit: $23,500 (up from $23,000 in 2024)
- Combined employer and employee limit: The lesser of your annual compensation or $70,000 (up from $69,000 in 2024)
- Income cap: Once your income reaches $350,000, neither you nor your employer can make further contributions for that year
What Is a 401(k) Catch-Up Contribution?
If you’re 50 or older, the IRS allows you to contribute more than the standard limit to help accelerate your savings as retirement approaches.
- Traditional 401(k) catch-up limit (age 50+): $7,500, bringing your total possible contribution to $30,500 in 2025
- SIMPLE IRA catch-up limit (age 50+): $3,500
What Are the Different Types of 401(k) Plans?
- Traditional 401(k). The most common type. Contributions are made pre-tax, reducing your taxable income now. You pay taxes when you withdraw funds in retirement. Employers can contribute, match, or both, but must pass IRS testing to ensure the plan doesn’t favor high earners.
- Roth 401(k). Contributions are made after tax, so you won’t owe taxes on withdrawals in retirement. A good option if you expect to be in a higher tax bracket later.
- Safe Harbor 401(k). Employer contributions vest immediately — the moment your employer contributes, the money is yours. These plans are exempt from standard IRS nondiscrimination testing.
- SIMPLE 401(k). Designed for small businesses. Easier to administer than a traditional 401(k), with immediate vesting of employer contributions and no IRS testing requirement.
How Do You Enroll in a 401(k)?
Getting started is straightforward. Here’s what to do:
- Check your eligibility. Some employers require you to complete a waiting period or reach a minimum age before enrolling.
- Sign up through your employer. Enrollment is typically handled through HR or an online benefits portal.
- Choose your contribution amount. Decide what percentage of your paycheck to contribute, keeping the annual limit and employer match in mind.
- Select your investments. Review the available options and choose a mix that aligns with your risk tolerance and timeline. If you’re unsure, your HR department or plan administrator can help.
What Are the Benefits of a 401(k)?
- Tax-deferred growth. You don’t pay taxes on contributions or earnings until withdrawal, allowing your money to compound faster.
- Higher contribution limits. You can contribute significantly more to a 401(k) each year than to a traditional or Roth IRA.
- Employer match. Free money added to your account — as long as you contribute enough to qualify.
- Automatic contributions. Paycheck deductions make saving consistent and remove the temptation to spend the money instead.
- Flexibility. You can contribute to both a 401(k) and an IRA in the same year, maximizing your tax-advantaged savings.
How Does a 401(k) Compare to an IRA?
| Feature | 401(k) | IRA |
|---|---|---|
| 2025 Contribution Limit | $23,500 | $7,000 |
| Tax Treatment | Pre-tax (traditional) or after-tax (Roth) | Pre-tax or after-tax depending on type |
| Employer Match | Yes | No |
| Investment Options | Limited to plan offerings | Broader selection |
| Best For | Maximizing contributions and capturing employer match | Supplementing a 401(k) with more investment flexibility |
Using both accounts together is a powerful strategy — a 401(k) for higher contribution limits and employer matching, and an IRA for broader investment choices or tax-free retirement income through a Roth.
Should You Open a 401(k)?
For most people, the answer is yes — especially if your employer offers a match. Not contributing enough to capture the full match means leaving free money behind.
The main exception is if you genuinely can’t afford the contributions right now. It’s also worth considering a Roth 401(k) or Roth IRA if you expect to be in a higher tax bracket in retirement — having some tax-free income available later can be a significant advantage.
If you have access to a 401(k), contributing to it consistently — even starting small — is one of the most reliable ways to build long-term financial security.
FAQ
- What is the main purpose of a 401(k)?
- A 401(k) helps you save for retirement by allowing you to contribute a portion of your income, often with tax advantages and potential employer matching.
- Can I have both a 401(k) and an IRA?
- Yes, you can have both, allowing you to take advantage of the higher contribution limits of a 401(k) and the additional tax benefits or investment options of an IRA.
- How much should I contribute to my 401(k)?
- Aim to contribute enough to take full advantage of any employer match and, if possible, save 10%–15% of your income to build a solid retirement fund.
- What happens to my 401(k) if I change jobs?
- You can leave your 401(k) with your old employer, roll it over to a new employer’s plan, transfer it to an IRA or cash it out, though the latter may have tax penalties.
- What is the difference between a Roth 401(k) and a traditional 401(k)?
- A Roth 401(k) uses after-tax contributions and offers tax-free withdrawals in retirement, while a traditional 401(k) uses pre-tax contributions but taxes withdrawals later.
- Are 401(k) plans worth it for retirement savings?
- Yes, 401(k) plans are a great tool for building retirement savings, thanks to their tax advantages, high contribution limits and potential employer matching.
- Yes, 401(k) plans are a great tool for building retirement savings, thanks to their tax advantages, high contribution limits and potential employer matching.
Cynthia Bowman, Rudri Patel and Vance Cariaga contributed to the reporting for this article.
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