What is 401K?
A 401(k) is an employer-sponsored retirement savings plan that lets you contribute pre-tax dollars from your paycheck, reducing your current taxable income while the money grows tax-deferred until you withdraw it in retirement. The name comes from Section 401(k) of the Internal Revenue Code, which created this account type in 1978.
How does a 401(k) work?
You elect a percentage or dollar amount from each paycheck to go into your 401(k) account before income taxes are calculated. Your employer sends this money to the plan administrator (typically Fidelity, Vanguard, Charles Schwab, or similar firms), where you choose from a menu of investment options—usually mutual funds, index funds, or target-date funds.
What is the employer match and how does it work?
Many employers match a portion of your contributions as an incentive—common formulas include 50% of the first 6% you contribute, or 100% of the first 3%. If you earn $60,000 and contribute 6% ($3,600) and your employer matches 50% of that, you receive an additional $1,800 in your account annually—an immediate 50% return on your contribution.
When can you withdraw money from a 401(k)?
You can take penalty-free withdrawals starting at age 59½. Before that age, distributions trigger a 10% early withdrawal penalty on top of ordinary income tax, with limited exceptions (permanent disability, certain medical expenses exceeding 7.5% of adjusted gross income, substantially equal periodic payments).
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How is a 401(k) different from a traditional IRA?
Both offer pre-tax contributions and tax-deferred growth, but a 401(k) has much higher contribution limits—$23,000 versus $7,000 for an IRA in 2024 ($30,500 versus $8,000 if age 50-plus). A 401(k) requires an employer relationship; you cannot open one on your own.
What is a Roth 401(k) option?
Some employers offer a Roth 401(k) alongside the traditional version. You contribute after-tax dollars (no upfront deduction), but all growth and qualified withdrawals after age 59½ are completely tax-free if the account has been open at least five years.
What happens to your 401(k) when you change jobs?
You have four choices: leave the money in your former employer's plan (if the balance exceeds $7,000), roll it into your new employer's 401(k), roll it into an IRA, or cash out. Cashing out triggers immediate taxes and the 10% penalty if you're under 59½.
FAQ
Can you borrow money from your 401(k)?
Most plans allow loans up to 50% of your vested balance or $50,000, whichever is less. You repay yourself with interest over five years (longer for a home purchase), but if you leave your job, the outstanding balance typically becomes due within 60–90 days or counts as a taxable distribution plus 10% penalty.
What fees do 401(k) accounts charge?
Plans charge administrative fees (recordkeeping, legal, trustee services) and investment fees (expense ratios on the funds you choose). Total fees range from 0.5% to 2% of assets annually.
Does a 401(k) protect your money from creditors?
Federal law (ERISA) shields 401(k) assets from most creditors and lawsuits, including bankruptcy, with unlimited protection. This is stronger than IRA protection, which caps at $1,512,350 (2024 limit) for bankruptcy, though state laws may offer additional IRA creditor protection outside bankruptcy.
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How the 401k calculation works
A 401k projection starts with the current balance and adds planned employee and employer contributions over time. It then applies an assumed rate of return, usually with periodic compounding. Actual results depend on investment performance, fees, contribution timing, vesting, and withdrawals. Review the current 401k limit and your plan documents because IRS limits and employer contribution formulas can change.
Traditional 401k contributions generally receive different current tax treatment from roth 401k contributions, while qualified withdrawal rules also differ. A 401k plan may offer limited investment choices and an employer match, whereas an IRA generally offers a separate contribution limit and broader provider selection. A solo 401k is designed for eligible self-employed individuals. A 403b plan and the federal TSP have their own rules and should not be treated as identical accounts.
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