What Is a 401(k)?

What Is a 401(k)?

A 401(k) is a tax-advantaged retirement savings account offered by employers in the United States. It lets you set aside a portion of your paycheck before taxes are taken out, which reduces your current taxable income and allows the money to grow tax-deferred until you withdraw it in retirement. Many employers also match a percentage of your contributions, which is essentially free money that accelerates your savings.

How a 401(k) Works

You choose how much of your salary to contribute, up to annual limits set by the IRS, and select investments from a menu provided by the plan. The two main types are traditional 401(k)s, where contributions are pre-tax and withdrawals are taxed as ordinary income, and Roth 401(k)s, where contributions are made with after-tax dollars and qualified withdrawals are tax-free. Investment options typically include index funds, target-date funds, mutual funds, and sometimes company stock.

Key Benefits

• Tax-deferred growth: investments compound without annual tax drag.
• Employer match: free additional contributions that boost your balance.
• Automatic payroll deductions: savings happen without manual effort.
• Portability: you can roll the account into an IRA or a new employer's plan when you leave.

Contribution Limits and Withdrawal Rules

The IRS sets annual contribution limits, and there is a separate catch-up limit for participants aged 50 and older. Withdrawals before age 59½ generally trigger a 10% early withdrawal penalty plus income tax, with some exceptions for hardship or specific qualifying events. Required minimum distributions begin at a specified age, which the IRS adjusts periodically.

401(k) vs. IRA

While both are retirement accounts, a 401(k) is tied to your employer and typically offers higher contribution limits and potential matching funds. An IRA is an individual account with more investment flexibility but lower annual limits. Many financial advisors recommend contributing enough to a 401(k) to capture the full employer match before funding an IRA.