- A 401(k) plan is an employer-sponsored retirement plan with substantial growth potential.
- Your 401(k) plans can be funded with pre-tax dollars or after-tax dollars.
- It's possible to withdraw money from a 401(k) early, but you'll have to pay taxes and penalties.
A 401(k) account can be a great way to save for retirement and minimize your tax burden. This employer-sponsored plan provides numerous long-term benefits, including tax advantages, making it one of the best retirement plans.
You can get the most out of your 401(k) plan by maximizing your annual contributions, taking advantage of your employer match, and lowering your taxable income.
How 401(k)s work
Here is what a 401(k) offers and how best to use it.
Definition and purpose of a 401(k)
A 401(k) plan is a tax-advantaged retirement account offered to employees of for-profit companies. It is named after Section 401, subsection k, of the US Internal Revenue Code.
Employees defer a portion of their taxable income into their 401(k) through automatic payroll contributions every pay period. Contributions to 401(k)s are usually pre-tax, offering the benefit of tax-deferred growth. So, you won't pay tax on that income until you withdraw during retirement.
A 401(k) is one of the most powerful retirement savings vehicles for employees to accumulate wealth over the long term. Determining how much you need to save for retirement can be tricky, but regularly contributing to your 401(k) can help you reach your retirement goals.
Investment options for 401(k)s
The investment options available in your 401(k) plan are determined by your plan administrator and employer. Common investment options include:
- Mutual funds
- Index funds
- ETFs
- Money-market funds
You decide which funds and what percentage of your contributions to invest in each fund. For example, you can divide your monthly contributions between a total market index fund and a bond index fund.
Review each fund's performance and select funds consistent with your risk tolerance and long-term financial goals for the best results.
Withdrawal rules for 401(k)
While technically you can withdraw from your 401(k) at any time, your 401(k) is a long-term savings vehicle, and withdrawing before you reach 59½ results in a 10% penalty fee from the IRS. Once you are of age, you can withdraw from your account penalty-free. Income tax still applies unless you're account was funded by Roth contributions.
In extreme financial emergencies, you may consider a 401(k) hardship withdrawal or 401(k) loan as a last resort. However, these options should only be pursued after exhausting all other options.
You must withdraw your required minimum distributions (RMDs) by age 73. If you are still working for an employer at that time, you may be able to delay taking RMDs. However, this exception generally does not apply if the employee has a substantial ownership interest in the employer.
Contribution limits in 2024 and 2025
Here's how much you contribute to your 401(k) plan in 2024 and 2025.
Employee contribution limit
The 2025 401(k) contribution limit is $23,500 if you're under 50. Those 50 or older can make an additional catch-up contribution of $7,500, bringing the maximum contribution amount to $31,000. These limits apply to traditional and Roth 401(k) plans.
The 2024 limits are $23,000 if you're under 50. Older employees can also make an additional catch-up contribution of $7,500.
Contributions cannot exceed an employee's income. For example, if you make $15,000 annually, you can't contribute $22,500 to your 401(k) plan.
Starting in 2026, you'll no longer be able to deposit catch-up contributions to a traditional 401(k) plan if you make over $145,000 annually. Instead, those contributions must be deposited into a Roth 401(k).
Total 401(k) contribution limit (including employer match)
Here are the total contribution limits for 401(k)s in 2025, including employer-match contributions:
| 401(k) Contribution Limits (2024) | Traditional 401(k) | Roth 401(k) |
| Maximum employee contribution | $23,500 | $23,500 |
| Employee catch-up contribution (age 50 or older) | $7,500 | $7,500 |
| Employee and employer maximum limit | $70,000 | $70,000 |
Here are the contribution limits for 401(k)s in 2024, including employer-match contributions:
| 401(k) Contribution Limits (2024) | Traditional 401(k) | Roth 401(k) |
| Maximum employee contribution | $23,000 | $23,000 |
| Employee catch-up contribution (age 50 or older) | $7,500 | $7,500 |
| Employee and employer maximum limit | $69,000 | $69,000 |
Benefits of a 401(k)
Employer-sponsored retirement plans like 401(k)s provide several benefits.
Tax advantages of 401(k)s
Tax advantages are one of the biggest benefits of contributing to a 401(k) plan. You can contribute pre- or after-tax money depending on your preferred tax advantage.
Traditional 401(k)s offer the benefit of an initial tax break by deferring a portion of your income into the account. So, you won't pay tax on that money until you withdraw during retirement. Pre-tax funded 401(k)s are ideal if you think you'll fall into a lower income tax bracket at retirement when you take taxable distributions.
Roth 401(k) plans are the opposite and are funded with after-tax dollars. Although there's no initial tax break, you benefit from tax-free growth and withdrawals. This tax advantage is best suited for employees who predict they will be in a higher tax bracket during retirement.
Employer match for 401(k)s
Some employers offer an employer-match contribution up to a certain limit. When an employee contributes a portion of their income to their 401(k) plan, the employer contributes a matching contribution dollar-for-dollar or a partial match. This is extra money on top of your contribution and will help your retirement account grow faster.
For example, an employer may offer to match an employee's contributions dollar-for-dollar up to the first 5% of the employee's salary.
Employer contributions often come with strings attached, such as a vesting schedule. Vesting means employer contributions and earnings are not the employee's property until certain conditions are met. Employers often require employees to be employed for a defined period before all employer contributions and earnings become the employee's property.
Ensure you understand your employer's match rules and contribute enough to your 401(k) to capture the full amount.
Automatic savings for 401(k)s
Employer-sponsored 401(k) plans offer the convenience of automatic savings through payroll deductions. Regular contributions are a proven strategy for building a substantial retirement nest egg. By automatically setting aside a portion of your paycheck, you eliminate the hassle of manual contributions and ensure consistent savings.
Compound growth with a 401(k)
Compound interest is like earning interest on your interest. As your money grows, so does the amount of interest you earn. The more you earn, the faster your money grows, making it easier to reach your goals.
One key advantage of a 401(k) is its ability to leverage the power of compound interest. While the short-term growth may seem modest, the long-term potential for accumulating wealth is substantial, especially when combined with investment gains.
When to start saving for retirement
You should begin saving for retirement as early as possible. Even minors can start contributing to a custodial IRA or similar account with the assistance of a parent or guardian, provided they have earned income.
A 401(k) is a powerful tool for retirement savings and tax optimization. It offers tax-deferred growth and often includes employer-matching contributions, accelerating wealth accumulation.
If possible, you should always contribute enough to your 401(k) to capture the full employer match. This is essentially free money, so you shouldn't pass on this opportunity to grow your retirement savings even more. But make sure you understand your employer's vesting schedule.
FAQs about 401(k)s
What is the difference between a traditional and a Roth 401(k)?
The difference between a traditional and a Roth 401(k) is how the account is funded and the resulting tax advantages. Since traditional 401(k)s are funded with pre-tax dollars, employees benefit from tax-deferred income. A Roth 401(k) is funded with after-tax dollars, offering tax-free growth and withdrawals later in retirement.
When can I withdraw money from my 401(k)?
Technically, you can withdraw money from your 401(k) at any age. But if you are not at least 59½, you will be charged a 10% early withdrawal fee from the IRS. You may qualify for a hardship withdrawal or loan in certain circumstances.
What happens to my 401(k) if I leave my job?
If you leave your job, you can roll over your 401(k) into a new 401(k) plan or IRA. A 401(k) rollover allows the funds in your account to continue growing without resulting in additional tax or penalties. However, unvested employer contributions will be lost.
