401(k) Basics — Everything You Need to Know

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

Step	What Happens
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: Never Leave the Match Behind

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

Term	What It Means
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

Real Example: The Cost of Not Getting the Match

Two coworkers, Sam and Alex, both earn $60,000/year. Their employer matches 50% of contributions up to 6% of salary.

Person	Contribution	Employer Match	Total Invested Yearly
Sam	6% ($3,600)	3% ($1,800)	$5,400
Alex	3% ($1,800)	1.5% ($900)	$2,700

Over 30 years at an 8% average return, this difference compounds into a gap of several hundred thousand dollars at retirement — purely because Alex didn't contribute enough to capture the full match.

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

Key Takeaway: Pre-tax contributions lower your taxable income today, and your money grows tax-deferred until withdrawal. Always contribute enough to get the full employer match — as the example above shows, missing it can cost hundreds of thousands over a career. The 2025 limit is $23,500 (or up to $34,750 if age 60-63), and early withdrawals before 59½ face taxes plus a 10% penalty.

Frequently Asked Questions

What happens to my 401(k) if I switch jobs?

You can roll it over into your new employer's 401(k) or into an IRA, leave it with your former employer if the plan allows, or in rare cases cash it out — though cashing out before 59½ triggers taxes and a 10% penalty.

Is the employer match part of my contribution limit?

No — the employee contribution limit ($23,500 in 2025) is separate from employer contributions. There's a higher combined limit for employee plus employer contributions together, which is rarely a concern for most savers.

What is a vesting schedule and why does it matter?

It's the timeline before employer-matched funds fully belong to you — leaving a job before you're fully vested can mean forfeiting some or all of the employer match, even though your own contributions are always yours.

Can I contribute more than the annual limit?

No — the IRS limit is a hard cap for employee contributions each year, though the "super catch-up" for ages 60-63 raises that cap specifically for savers closer to retirement.

What if my 401(k)'s default investment feels too conservative?

Log into your plan's portal and check what your contributions are actually invested in — many defaults are money market or stable value funds, and switching to a target-date or index fund is usually simple to do yourself.

Are there exceptions to the 10% early withdrawal penalty?

Yes, certain circumstances like specific hardships, disability, or separation from service after age 55 in some cases can allow penalty-free withdrawals — but regular income tax on the withdrawal still generally applies.