If you entered adulthood without knowing what a 401(k) is, don't feel bad. Most people don't take the time to really learn about it until they land their first job and their employer offers one.
But for many people, it can be the single-best way to save money for retirement. And also the easiest, in that you can basically “set it and forget it.” This article covers all the basics of 401(k) retirement plans and answers common questions.
What is a 401(k)
A 401(k) is an employer-sponsored retirement plan that allows you to save money for retirement directly from your paycheck. Because it's employer-sponsored, you can only open a 401(k) account if your employer offers you one. Typically, an employer will also contribute to your 401(k) account (more on that in a bit).
Types of 401(k)
There are multiple types of 401(k) plans. However, the two most commonly offered by employers are a traditional 401(k) and a Roth 401(k). The main difference between the two plans is whether contributions are made with pre- or post-tax dollars. Here's a Roth vs 401(k) comparison:
- Roth 401(k): This plan is the opposite of the traditional 401(k). Your contributions are deducted from your paycheck after taxes. In your retirement, you don't have to pay taxes on your withdrawals.
- Traditional 410(k): In this plan, your contributions are deducted from your gross income (meaning your salary before taxes). Once you retire and start withdrawing from the account, the money is subject to taxes.
Note: Don't confuse the Roth 401(k) with the Roth IRA. IRA stands for individual retirement account, and Roth IRAs aren't employer-sponsored. This means you choose when and where to open an account, and decide how much you want to contribute yearly.
Why is it called 401(k)?
You might assume the name 401(k) has something to do with how much you can save or how much you need for retirement. But that's not the case. It's named after the section of the U.S. Internal Revenue Code that created this retirement plan in 1978.
As for the Roth 401(k), its name comes from William Roth, a former U.S. Senator from Delaware. He was the primary sponsor of the legislation that made this type of retirement plan possible.
What is a 401(k) withdrawal?
“Withdrawal” refers to the act of cash out from your 401(k) account. Unlike a loan, a withdrawal doesn't require you to pay back the amount you took—it's optional. However, there might be penalties if you make a withdrawal before retirement age.
How does a 401(k) work
401(k) accounts are retirement investment accounts. You make contributions and the money is invested in assets, such as stocks, mutual funds, and bonds—pottentially growing your balance over the years. Employers typically match their employees' contributions up to a certain amount or percentage, meaning you get money “for free,” which also increases your retirement cushion.
Because a 401(k) is a retirement plan, you can't make withdrawals as you please—and there are rules set in place to ensure that you won't touch the money before reaching retirement age. As of January 2025, the minimum age to withdraw from a 401(k) is 59½. Any withdrawal made before that is considered a “premature distribution” and you must pay an additional 10% over the amount you take.
The IRS does have a list of exceptions to tax on early distributions. For example, if you're partially or permanently disabled, or are taking the money to cover for medical expenses, the IRS may waive the early-withdrawal penalty.
Maximum contribution to a 401(k)
The IRS imposes a limit to how much you can contribute to a 401(k) plan each year. In 2025, the maximum contribution to a 401(k) is $23,500 for under 50. If you're 50 or older, you can deposit an additional $7,500 in for “catch-up” contributions. These maximum amounts are updated annually by the IRS to account for inflation.
How does employer matching work
Simply put, employer matching contributions refer to a certain amount of money your employer will contribute to your 401(k), aside from the money already deducted from your paycheck. That's why it's considered “free money.” As it's not mandatory, not all employers offer matching. The ones who do have their own unique formula to calculate it.
For example, some employers will match $1 for every $2 an employee contributes. There are employers who offer a full match, also known as dollar-for-dollar match, which means that if you contribute $10 they'll also contribute $10. In other instances, an employer might match your contributions up to a certain percentage of your salary, like 2% or 5%. In most cases, financial experts recommend you contribute as much as you can to get the full employer match. (Again, it’s a matter of getting all the “free money” that’s offered to you.)
However, employer matching contributions also are limited by the IRS. For workers under 50, the combined limit for both contributions (your and your employer's) is $69,000 per year. For workers over 50 with catch up contributions included, the limit is $76,500 per year.
Pros and cons of 401(k) retirement plans
Both the traditional and the Roth 401(k) have their own mixture of pros and cons. Let's tackle them individually:
Pros of a traditional 401(k)
The traditional 401(k) has immediate tax benefits. “The contribution reduces your adjusted gross income (AGI) and brings down your tax liability,” says Joseph Favorito, a certified financial planner (CFP) and managing partner of Landmark Wealth Management, LLC. “Additionally, the money grows tax deferred therefore it compounds faster.”
In other words, your taxable income at the end of the year will be lower if you contribute pre-tax dollars to your 401(k). And that untaxed money will grow thanks to compound interest.
Cons of a traditional 401(k)
A traditional 401(k) is subject to required minimum distributions (RDMs) after you reach retirement age—which refers to the minimum amount of money you have to withdraw from your account yearly. Even if you don’t need the money. (We should all be so lucky.) This is determined by the IRS.
On the other hand, if you take cash out before age 59 ½, you're subject to the 10% early-withdrawal penalty and the withdrawal amount counts as taxable income for that year.
Pros of a Roth 401(k)
Because a Roth 401(k) is filled with your income after taxes, your contributions grow tax-free toward retirement. This means that any withdrawal made after you reach retirement age isn't subject to taxes. A second benefit is that as of 2024, Roth 401(k)s aren't subject to RDMs—so you can leave your money in your plan until you really need it.
Cons of a Roth 401(k)
One of the cons of a Roth 401(k) is also on its pros list: your contributions are made with post-tax dollars—meaning the IRS takes their cut first, which reduces your today's income. Also, like the traditional plan, you cannot touch the money until 59½.
“You have no access to the money until retirement with a few exceptions, which give you less current liquidity,” Favorito says. On top of the 10% penalty for early withdrawals, if your contributions earned money they'll be prorated and taxed.
Required minimum distributions (RDMs)
As established by the IRS, traditional 401(k) account holders cannot keep money in their accounts indefinitely. At a certain age, it's mandatory that you start to cash out a minimum amount every year—this amount is your RDM and it is calculated based on your life expectancy.
In 2025, individuals who will be 73 years old (or older) at the end of the year have to start taking RDMs. In 2023, it was 72—so keeping up with the IRS updates throughout the years is important.
Because the worksheets the IRS provides on their website can be complicated to find and understand, the government has a required minimum distribution calculator. It details exactly how much you must take based on your account balance and age.
How do you make money on a 401(k)?
Your 401(k) earns money in two different ways: through investments and compound interest.
Investments: The money in your account is invested according to the options offered by your employer. Generally, you can invest in stocks, exchange-traded funds (ETFs), mutual funds, and bonds, but there might be other investments available depending on the plan offered to you.
Compound interest: As you contribute, the returns of your savings are reinvested in the account, which generates returns of their own. If your employer matches your contributions, the compounding effect can make your 401(k) grow significantly over time.
How to start a 401(k)
A 401(k) is an employer-sponsored retirement plan, meaning you can only participate if your employer offers it and sets up an account for you. The process is typically simple.
- Ask your employer. Contact your employer and ask if there's a 401(k) available and whether there's an employer match.
- Sign up. If the answer is yes, the company will take you through the proper steps and paperwork necessary to sign up.
- Choose your investments. Your employer determines the investments available for you, but it's your responsibility to pick the investment you want.
Once everything is set and ready, your contributions will be deducted from your salary monthly. If you're wondering whether you can manage and change your investments after opening the account, the good news is, you can.
“Employees can reallocate their existing assets, choose new funds, or shift their contributions to different investment options,” says Michael Boggiano, managing partner at Wealthcare Financial. “The specific process will depend on the plan provider, but generally, it involves logging into the 401(k) account online or contacting the plan administrator to make changes.”
However, there may be some restrictions depending on the plan. “Many plans allow changes to be made at any time, but some might limit the number of changes or impose restrictions in certain situations,” Boggiano says.
What happens to your 401(k) when you quit?
If you quit your job, your contributions to your 401(k) remain yours and the IRS rules still apply. You can choose to keep your funds in that account or rollover to your new employer's plan or to an IRA, Favorito says.
However, the money your employer contributed may be subject to a “vesting schedule.” This term refers to a number of service years you must work for the same employer until their contributions become fully yours. “Typically, after six years of service plus 1000 hours, most employees are fully vested and can take the employer contribution as well,” he says.
Once you're vested, the money becomes 100% yours and the employer cannot take it back for any reason. This applies whether you quit or you're fired. “There’s no significant difference between quitting voluntarily or being terminated when it comes to the ownership of the 401(k),” says attorney Kalim Khan, founder of Affinity Law, where he specializes in employment law.
Read this next: Rollover Ira vs Roth Ira: What's the Difference? Understanding Retirement Planning Options
How can a stock sell-off impact your 401(k)?
A stock sell-off could represent short-term losses in your 401(k), depending on how much you invested in it. “The impact largely depends on how much exposure you have to stocks versus other asset classes like bonds or cash equivalents,” Boggiano says. “If your portfolio includes a substantial portion of stocks, you might see short-term losses during a sell-off.”
However, that shouldn't matter much unless you’re near retirement. “If you’re still a long way from retirement, it shouldn’t be too concerning, as market volatility is quite normal,” Favorito says. “The employee should allocate the plan accordingly with their timetable for retirement, and with the help of a financial planner if needed.”
In that case, a stock sell-off could even be an opportunity for profit. “A market downturn could also present opportunities to buy investments at lower prices, potentially boosting long-term returns,” Boggiano says. “It's critical not to panic in these situations and to stay focused on your long-term investment strategy, unless your investment goals or risk tolerance change.”
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FAQs
Is a 401(k) mandatory in the U.S.?
No, it's not mandatory for an employer to offer a 401(k) to their employees in the U.S. “Employers have the discretion to decide whether to provide this benefit,” Khan says. “However, some states, like California and Oregon, have introduced mandates requiring certain employers to either offer their own retirement plan or enroll employees in a state-sponsored retirement savings program.”
Are 401(k)s good or bad?
No retirement plan is inherently good or bad—they all have pros and cons. However, 401(k)s are considered one of the best options out there, especially if you couldn't fund a retirement plan otherwise. “It’s recommended to anyone it’s offered to—it’s a great way to save,” Favorito says. “If you don’t have a traditional pension, you should save as much as you can, but no less than 10% of your annual income.”
Does my money grow in 401(k)?
Yes, your contributions to your 401(k) grow overtime, whether through your employer's matching contributions, earned interest, or returns of your investments.
Can I keep my 401(k) if I leave the U.S.?
Yes, you can. “For those leaving the U.S. permanently, the 401(k) remains accessible but subject to the same rules, including potential penalties for early withdrawal before age 59½,” says Edward Hones, employment lawyer and founder of Hones Law PLLC. “Expats must also navigate tax implications in both the U.S. and their new country of residence, which underscores the importance of financial and legal advice when relocating internationally.”
What happens if you don't want a 401(k)?
If your employer offers you a 401(k) and you don't want it, you can decline the offer. “It's up to the employee whether they wish to participate,” Hones says. Your employer might request that you formalize your declination. “Employers may require employees to sign a waiver or decline the plan in writing for documentation purposes,” Khan says.
Can a non-U.S. citizen have a 401(k)?
Any person who has a permit to reside and work in the U.S. can have a 401(k), even if they aren't citizens. “Non-U.S. citizens who are legal residents are fully eligible to participate in 401(k) plans if their employer offers one,” Hones says. “The primary criteria are residency and employment status, not citizenship.”
How does a 401(k) work when you retire?
Once you reach retirement age (which for the IRS is 59½), you can do whatever you want with your 401(k). You could take a lump sum from the account, convert it into an annuity (if your plan allows it), transfer the money to an IRA, or wait until you’re required to take the required minimum distributions. Consult with a financial advisor to learn more about your options.
How do you make money on a 401(k)?
You make money on a 401(k) by investing your contributions. Your investment options are limited to what your employers offer you, but generally include stocks, bonds, ETFs, and mutual funds.