A Simple Guide to 401(k)

On February 25, 2026 By newsroom Topic: Saving And Investing Money

What is a 401(k)?

A 401(k) is an employer-sponsored, tax-advantaged retirement account. There are two primary types:

Traditional 401(k): Contributions are made pre-tax, reducing taxable income now, but withdrawals in retirement are taxed.
Roth 401(k): Contributions are made after-tax, so withdrawals (including growth) in retirement are tax-free.

Employers often match contributions, which is essentially free money added to your retirement savings.

How Does a 401(k) Work?

Contributions: Deducted automatically from your paycheck.
Investments: Funds are typically invested in options like mutual funds or target-date funds offered by your plan provider.
Growth: Money grows tax-deferred (traditional) or tax-free (Roth).
Withdrawals: Funds are accessed during retirement, with specific rules for each 401(k) type.

401(k) Contribution Limits

| Limit Type | Amount |
|------------------------------------|------------------|
| Employee Contribution | $23,000 |
| Catch-Up (50+) | Additional $7,500|
| Employee + Employer Combined | $69,000 (under 50) or $76,500 (50+) |

Benefits of a 401(k)

Higher Contribution Limits: Exceeds limits of Individual Retirement Accounts (IRAs).
Employer Match: Free contributions from your employer.
Tax Advantages: Tax-deferred or tax-free growth depending on account type.
Automated Saving: Contributions directly from your paycheck.

Drawbacks of a 401(k)

Limited Investment Options: Compared to IRAs, choices may be restricted.
Fees: Higher administrative fees than other retirement accounts.
Withdrawal Restrictions: Early withdrawals face penalties unless specific criteria are met.

Traditional 401(k) vs. Roth 401(k)

| Feature | Traditional 401(k) | Roth 401(k) |
|---------------------------|---------------------------------------|---------------------------------|
| Tax Treatment | Contributions reduce taxable income now; withdrawals taxed in retirement. | Contributions are after-tax; withdrawals (including growth) are tax-free. |
| Required Minimum Distributions (RMDs) | Start at age 73. | No RMDs (if rolled into a Roth IRA). |
| Best For | Those who expect to be in a lower tax bracket in retirement. | Those who expect to be in a higher tax bracket in retirement. |

401(k) Withdrawal Rules

Qualifying Withdrawals: At age 59½, with certain disabilities, or hardship withdrawals.
Early Withdrawals: Subject to a 10% penalty and income tax unless exceptions apply.
RMDs: Begin at age 73 for traditional accounts. Roth 401(k)s are exempt.
Emergency Withdrawals: Starting in 2024, up to $1,000/year without penalty for emergencies (must be repaid within three years).

What Happens If You Leave Your Job?

Options include:
1. Roll Over: Transfer funds into a new employer’s 401(k) or an IRA (typically tax-free if done within 60 days).
2. Leave It: Keep funds in your old employer’s 401(k) but no longer contribute.
3. Withdraw: Take the money (subject to taxes and penalties if early).

Key Next Steps

Aim to contribute 10%-15% of your income or enough to get the full employer match.
Consider both a 401(k) and an IRA for a diversified retirement strategy.
Use NerdWallet’s 401(k) calculator to estimate your future balance.

A 401(k) is a cornerstone for building a solid retirement plan. Take advantage of any employer match, contribute regularly, and choose investments aligned with your goals!