401(k) Basics — Everything You Need to Know

The most powerful retirement account most employees never fully use.

What is a 401(k)?

A 401(k) is a retirement savings account offered by your employer. You choose how much of your paycheck to contribute (up to IRS annual limits), and that money gets invested in funds you select — typically a mix of stock and bond mutual funds or index funds.

The big advantage: contributions come out of your paycheck before taxes. If you earn $60,000 and contribute $6,000, you only pay income tax on $54,000 that year. Your money then grows tax-deferred until retirement.

How It Works

You contribute pre-tax dollars

Money is taken from your paycheck before income taxes are applied, lowering your taxable income for the year.

Your employer may match

Many employers match a portion of your contribution — this is essentially a 100% instant return on that money.

Your money grows tax-deferred

Investments inside your 401(k) compound over time without being reduced by annual capital gains or dividend taxes.

You withdraw in retirement

Starting at age 59½ you can withdraw funds. Withdrawals are taxed as ordinary income at your then-current tax rate.

2025 Contribution Limits

Who	Annual Limit
Under age 50	$23,500
Age 50–59 or 64+ (catch-up)	$31,000
Age 60–63 (super catch-up)	$34,750

Limits are set by the IRS and typically adjust each year for inflation.

Key Insight: If your employer matches 50% of contributions up to 6% of your salary, contribute at least 6%. Anything less means you're leaving free money on the table — that match is part of your compensation.

Key Terms

401(k)

An employer-sponsored retirement savings plan that lets you contribute pre-tax dollars, reducing your taxable income today.

Tax-Deferred

You don't pay taxes on contributions or growth now — only when you withdraw the money in retirement.

Employer Match

Free money your employer adds to your 401(k) based on how much you contribute — typically 50%–100% up to a certain percentage of your salary.

Vesting Schedule

The timeline that determines when employer contributions officially become yours. You always own your own contributions immediately.

Common Mistakes to Avoid

Not enrolling at all — many plans require you to opt in manually.
Withdrawing early — before 59½ you'll pay taxes plus a 10% penalty.
Leaving the default investment — most defaults are too conservative for young savers.
Forgetting old 401(k)s — when you switch jobs, roll over your old account so it keeps growing.

Quick Summary
Pre-tax contributions lower your taxable income today
Money grows tax-deferred until withdrawal
Always contribute enough to get the full employer match
2025 limit is $23,500 (or up to $34,750 if age 60–63)
Early withdrawals before 59½ face taxes + 10% penalty

Roth IRA — The Tax-Free Wealth Builder