401(k)

A 401(k) is a workplace retirement plan that lets employees defer part of their salary into an investment account with tax advantages. The name comes from the section of the tax code that created it. Contributions happen by payroll deduction, which makes saving automatic, and most plans offer a menu of mutual funds or target-date funds to invest in. Two features distinguish it from saving on your own. First, the contribution limits are much higher than an IRA's. Second, many employers contribute matching money when you do, which is compensation you only receive if you participate.

Most plans now offer two flavors. Traditional (pre-tax) contributions are excluded from your taxable income today; the money grows untaxed and every dollar you withdraw in retirement is taxed as ordinary income. Roth 401(k) contributions get no deduction now, but qualified withdrawals in retirement are entirely tax-free, and since 2024 Roth 401(k) accounts no longer have lifetime required minimum distributions. The choice mostly turns on whether your tax rate is higher now or will be higher later.

The 2026 employee deferral limit is $24,500. Workers 50 and older can add an $8,000 catch-up, and a temporary "super" catch-up of $11,250 replaces it for those aged 60 through 63. One new wrinkle takes effect in 2026: under SECURE 2.0, anyone whose prior-year Social Security (FICA) wages from that employer exceeded $150,000 must make catch-up contributions as Roth. There is also a separate, higher overall cap on combined employee and employer contributions, adjusted annually (see IRS.gov).

Employer matches commonly follow a formula such as 50 cents per dollar on the first 6% of pay you contribute. Your own contributions are always 100% yours, but employer money may vest on a schedule--commonly a three-year cliff or gradual vesting over up to six years. Leave before vesting and you forfeit the unvested portion. Finally, plans charge fees at two layers: the expense ratios of the funds you choose and, in some plans, administrative or recordkeeping charges. A high-fee plan is usually still worth funding up to the match; beyond that, the math depends on the fees.

A hypothetical example: Priya earns $100,000 and contributes 10% of pay, or $10,000, to her traditional 401(k). Her employer matches 50 cents per dollar on the first 6% of pay, adding $3,000. Her taxable income drops by the $10,000 she deferred, and $13,000 lands in her account for the year, invested in the target-date fund she selected.

Her plan vests employer money gradually at 20% per year. If she left after two years, she would keep all of her own contributions and their growth but only 40% of the employer contributions. When she eventually changes jobs, she can leave the balance in the old plan (if large enough), move it to her new employer's plan, or do a direct rollover to an IRA. A direct rollover, where the money moves between custodians without passing through her hands, avoids the mandatory 20% withholding and 60-day deadline that apply when a check is made out to her personally.

Pros

• High contribution limits compared with IRAs, plus automatic payroll deduction that makes saving the default.
• Employer matching is additional compensation with no equivalent outside the plan.
• Pre-tax contributions lower this year's tax bill; Roth contributions build tax-free retirement income.
• Strong protection from creditors under federal law, and a penalty exception if you leave your employer in or after the year you turn 55.

Cons

• Investment choices are limited to the plan's menu, which varies in quality and cost.
• Withdrawals before age 59 1/2 generally face a 10% penalty on top of tax, with limited exceptions.
• Employer contributions may take years to vest.
• Fees are often hard to see because they're deducted inside the funds rather than billed to you.