What is a 401(k) plan? A comprehensive guide

A 401(k) plan is one of the most popular ways to save for retirement in the US. Recent data shows that 60% of Americans put away money for the future in a 401(k) or similar account. CNBC also reports all-time high savings rates for this type of plan. 

Employers often sponsor a retirement plan as part of their benefits package. Workers must decide how much to contribute and how to invest. Some employers also add matching contributions.

Explore how 401(k)s work and discover their limitations and benefits. Plus, learn about employer matching programs and the difference between traditional and Roth accounts. Clear knowledge helps people save for retirement with confidence and avoid costly mistakes. 

What is a 401(k) plan?

A 401(k) retirement plan is an employer-sponsored savings fund that offers tax advantages. These tax benefits differ based on the type of plan and how the IRS treats contributions and earnings. Some workers receive a tax break in the current year through pre-tax contributions, while others gain tax-free withdrawals later. 

A 401(k) plan encourages workers to save by automating deposits. Research shows that people are more likely to put money away for retirement if they make this decision ahead of receiving their paycheck. Plus, withdrawing money from a 401(k) often incurs penalties, discouraging employees from tapping into their savings early.

How does a 401(k) work?

Employees can direct a percentage of their income from each paycheck into their 401(k) account. The payroll team withholds that amount and directs it into the retirement account through automatic deductions. 

Funds in a 401(k) plan grow over time via investments employees choose based on their risk tolerance. For example, higher risk-takers may invest their 401(k)s in stocks or mutual funds, while the risk-averse might choose more conservative options like bond funds.

The difference between a traditional 401(k) and a Roth 401(k)

There are two types of 401(k)s—traditional and Roth—and the primary difference between them is how the tax benefits work. Here’s more on each.

Traditional 401(k)

In this retirement savings plan, an employee can route a percentage of their pre-tax paycheck to their 401(k) fund before federal income tax deductions. As a result, they pay less in taxes in the present. But when they withdraw 401(k) funds in the future, the IRS taxes them as ordinary income at the rate corresponding to the person’s tax bracket at the time of withdrawal.

Roth 401(k)

In the Roth 401(k) model, employees send a percentage of their after-tax paycheck to their retirement savings account. There’s no in-the-moment tax benefit like there is with traditional 401(k)s, but there’s a future perk. People pay no taxes on the funds they withdraw after hitting the age of 59½, lessening their tax burden in retirement.

401(k) employer matching

Employer match programs help employees maximize savings. Through these programs, employers add funds to the 401(k) at a certain percentage rate, corresponding to an employee’s contributions. For example, if a person puts $5,000 annually in a 401(k) with a 50% match, the employer would deposit an additional $2,500 into the fund. 

An important factor to consider in employer matching programs is vesting—the percentage of funds that rightfully belong to an employee, should they leave the company. While a person's contributions to their 401(k) will always be theirs, employer-matched funds may not be theirs until they’ve been with the company for a certain amount of time.

Types of 401(k) employer contributions

Employers use several methods to add money to a retirement account. These methods benefit employees by supporting savings growth. They may also help companies meet IRS rules for running a fair plan. For example, safe harbor contributions allow employers to bypass certain annual nondiscrimination tests—such as the Actual Deferral Percentage and Actual Contribution Percentage tests—by making guaranteed contributions to employees’ 401(k)s

Employers typically contribute at fixed matching percentages or rates that correspond to individual income or total employee compensation at the company. The following are four popular employer contribution methods.

Partial match

A partial match is when an employer adds a percentage of the employee’s contributions to a 401(k). Employers often also stipulate up to what percentage of a salary they’ll apply this partial match. This method rewards consistent contributions and encourages long-term saving.

Dollar-for-dollar match

In this model, the employer offers a 100% match on contributions up to a certain percentage of a person's salary. Suppose a person earns $60,000 per year and the employer matches contributions up to 10% of their income. The employer would then match up to $6,000.

Non-elective contributions

Some employers add funds to employees’ 401(k)s, regardless of how much employees contribute themselves. For example, the employer contribution might be a set percentage of the person’s compensation—not a percentage correlating to how much the employee saves in their 401(k). This ensures every worker receives support in building a retirement account.

Profit-sharing contributions

Employer profit-sharing contributions depend on company performance. Employees may save as much or as little as they wish, and the employer will still deposit a certain amount into their 401(k)s. 

Companies use different calculation methods to determine how much each employee will receive. For example, a “comp-to-comp” method divides an individual’s compensation by the total compensation—the sum of all employee earnings. Employers then multiply that figure by the company’s contribution amount to determine the employee’s share. 

Key 401(k) benefits

For many, a 401(k) presents a straightforward retirement savings option that requires little day-to-day maintenance or thought. Here’s how employees stand to benefit from saving this way.

• Tax advantages: Employees can reduce income taxes through pre-tax contributions or enjoy tax-free withdrawals through a Roth structure.
• Automatic payroll deductions: Contributions move directly from salary into the retirement account, which supports consistent savings.
• Investment growth: A 401(k) allows savings to grow through investment options inside the retirement account. Earnings increase as the underlying investments gain value over time.
• Employer matching: At a company with employer 401(k) matching programs, employees can gain additional funds without having to increase their own contributions. 

401(k) contribution limits

The IRS sets annual maximum contribution limits for 401(k)s, meaning that people can’t invest above a certain amount. In 2025, the maximum amount an individual could funnel into this account is $23,500 and will increase to $24,500 in 2026. 

People 50 and over are eligible to make additional “catch-up” contributions. The IRS’s 2025 limit for this is $7,500 and will bump to $8,000 in 2026. People between 60 and 63 years of age are able to put away even more, up to $11,250. 

Regardless of a person's age or salary, individual contributions may not exceed 100% of a person’s annual income. Contribution limits also apply to employer matching programs. In 2025, the total contribution from the individual and employer must stay under $70,000.

401(k) withdrawal rules

In most cases, people need to hit 59½ years of age to withdraw funds from their 401(k) account without penalties. But sometimes, they find themselves needing money sooner due to difficult financial situations. 

Generally, early withdrawal penalties—an additional 10% tax on top of income tax—apply. However, the IRS makes exceptions and won’t levy this surcharge when people use the funds to cover certain costs. This includes disability, first-time homebuyer costs, and birth or adoption expenses.

Another key rule to know is the required minimum distribution (RMD)—an amount that retirees must withdraw from their 401(k)s each year after hitting 73 years of age. People can calculate this figure by dividing their account balance as of December 31 of the prior year by the IRS’s “distribution period” designation, which varies for each age.

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FAQ

How much should I contribute to my 401(k)?

Financial services companies like Fidelity and PNC recommend putting 10–15% of income in a 401(k). This range supports steady growth inside the retirement account and helps workers prepare for future withdrawals.

What is the difference between a 401(k) and a defined benefit plan? 

Defined benefit plans, like pensions, provide a consistent, predictable income to retirees. But 401(k)s are variable, and the final amount saved depends on the employee and employer contributions and investment options.

What state benefits do US retirees receive? 

US retirees receive statutory benefits—state-mandated—in addition to employer-based retirement perks. For example, retirees receive regular Social Security payments and access to Medicare.

What’s the difference between a Roth 401(k) and a Roth IRA?

A Roth 401(k) is an employer-sponsored retirement plan that uses after-tax dollars and offers tax-free withdrawals. A Roth individual retirement account is a savings plan with flexible investment options and separate IRS contribution limits. It’s a plan anyone can use to save.

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