What Is a 401(k)?
In plain English
A 401(k) is an employer-sponsored defined-contribution retirement plan that allows employees to save and invest a portion of their paycheck before taxes are taken out. Contributions grow tax-deferred until withdrawal in retirement, at which point they are taxed as ordinary income.
How Do 401(k) Contribution Limits Work?
The IRS sets annual 401(k) contribution limits that adjust periodically for inflation. For 2026, employees can contribute up to $23,500 per year. Workers aged 50 and older can make catch-up contributions of an additional $7,500, bringing their total to $31,000. These limits apply to your own contributions, not employer matches.
What Are the Tax Benefits of a 401(k)?
Traditional 401(k) contributions are made pre-tax, lowering your taxable income in the year you contribute. Your investments grow tax-deferred, meaning you pay no taxes on dividends or capital gains until you withdraw. Many employers also offer Roth 401(k) options, where contributions are after-tax but withdrawals in retirement are tax-free.
What Happens If You Withdraw From a 401(k) Early?
Withdrawing from a 401(k) before age 59½ typically triggers a 10% early withdrawal penalty on top of ordinary income taxes. Certain hardship exceptions exist, including disability, large unreimbursed medical expenses, and separation from service at age 55 or older. Loans from a 401(k) are another option to access funds without immediate penalties.
Frequently asked questions
Should I contribute to a traditional or Roth 401(k)?
If you expect to be in a higher tax bracket in retirement, a Roth 401(k) is often better. If you want to lower your tax bill now and expect a lower tax rate later, a traditional 401(k) makes more sense. Many people benefit from splitting contributions between both.
What happens to my 401(k) if I change jobs?
You can leave it with your former employer, roll it into your new employer's plan, roll it into an IRA, or cash it out. Rolling over to an IRA or new plan avoids taxes and penalties and keeps your savings growing.
Keep exploring
Related terms
Employer Match
An employer match is free money your company contributes to your retirement account to match a portion of your own contributions — widely considered the best return on investment available.
Roth IRA
A Roth IRA is an individual retirement account where you contribute after-tax dollars and your investments grow tax-free, with tax-free withdrawals in retirement.
Rollover IRA
A rollover IRA receives funds transferred from an employer-sponsored retirement plan like a 401(k), preserving tax-deferred status while giving you control over investment choices.
Catch-Up Contributions
Catch-up contributions allow workers aged 50 and older to contribute extra money to retirement accounts beyond standard annual limits, helping them accelerate savings before retirement.
Defined-Contribution Plan
A defined-contribution plan specifies how much employers and employees can contribute to a retirement account, but the ultimate benefit depends on investment performance.
Vesting
Vesting is the process by which employees earn ownership of employer-contributed retirement benefits over time, typically requiring a minimum number of years of service.