401(k), in plain English

A 401(k) plan is a retirement savings plan sponsored by an employer that allows employees to save and invest for their future. It’s named after the subsection 401(k) of the U.S. Internal Revenue Code.

Most full-time jobs offer one. Most people contribute the wrong amount to it — usually because nobody walked them through how it works. This guide does that.

How a 401(k) works

  • Employer-sponsored. These plans are offered by companies to their employees.
  • Defined contribution. Your retirement benefit depends on how much you and your employer contribute and what those investments earn — unlike an old-school pension, where the benefit is predetermined.
  • Salary deferral. You can choose to contribute a portion of your paycheck before taxes are taken out (in a traditional 401(k)). That reduces your taxable income for the year.

Traditional vs. Roth

Traditional 401(k)

  • Contributions are made pre-tax: the money is deducted from your paycheck before income tax.
  • Your taxable income drops in the year you contribute.
  • Investment earnings grow tax-deferred.
  • Withdrawals in retirement are taxed as ordinary income at your retirement-year marginal rate — the same bracket your wages would land in. (See mental models for tax thinking for what marginal means in practice.)

Roth 401(k)

  • Contributions are made after-tax: you pay income tax on the money before it goes in.
  • Your taxable income is not reduced in the year you contribute.
  • Investment earnings grow tax-free.
  • Qualified withdrawals in retirement (after age 59½, with at least five years since your first contribution to this specific Roth 401(k); the five-year clock is per-plan, unlike a Roth IRA where it spans your whole Roth-IRA history) are tax-free.
Plain English

Traditional = tax break now, taxes later. Roth = taxes now, no taxes later. Which one wins depends on whether you’ll be in a higher or lower tax bracket in retirement.

$1,000 pre-tax · 22% bracket · 30 years · 7%

Both paths land at $6,331. Only the tax timing differs.

Same $1,000 of pre-tax income, same 22% bracket both today and at retirement, same 30 years of growth. The tax bite just falls at a different point in time.

Source: 22% bracket assumed equal at contribution AND withdrawal; 7% real return, monthly compounding at r/12; 30 years.
Traditional Tax later
$1,000 pre-tax
Tax −$1,786
$1,000 grows to $8,116 over 30 years
$6,331 take-home
Roth Tax now
$1,000 pre-tax
Tax −$220
$780 grows to $6,331 over 30 years
$6,331 take-home

Bracket-shift cases break the tie. Lower bracket at retirement? Traditional wins. Higher? Roth wins.

2026 contribution limits

The IRS sets annual limits on how much you can contribute to a 401(k). These are the maximums — you can always contribute less.

IRS · 2026 limits

Annual 401(k) contribution caps

Employee contribution (under 50) $24,500
Catch-up contribution (50+) +$8,000
Maximum total (incl. employer) $72,000

Workers ages 60–63 get an enhanced catch-up up to $11,250 per SECURE 2.0 — a narrow band that doesn’t affect most readers, but worth knowing exists if you’re in it.

Employer matching

Many employers offer to match a portion of your contributions. A common formula: 50% match on the first 6% of your gross pay you contribute. Employer matching is essentially free money — once it vests. A typical schedule grants 20% per year of service (“graded”), or 100% after a single threshold like 3 years (“cliff”); leave before then and the unvested portion returns to the employer. With that caveat, the match significantly boosts your retirement savings over time.

Don't skip this

If your employer matches, contribute at least enough to get the full match. You set the deferral percentage in your benefits portal (often under “Retirement” or “401(k) Election”) — most providers let you change it any pay period. Anything less is leaving guaranteed return on the table. Run your number in the Employer Match Calculator.

$60,000 salary · 50% on first 6% · 10 years · 7%

What the match becomes.

Free money your employer adds to your 401(k), grown at 7% for a decade. The leverage is the difference between bars.

Source: $60,000 salary, 50% on first 6% match, 7% real, monthly compounding at r/12 over 10 years.
  • No contribution 0% employee
    $0 −$26K missed
  • Half match 3% employee
    $13K −$13K missed
  • Full match 6% employee
    $26K
Try the calculator
Employer match calculator

See what under-contributing costs you over a decade.

Open the calculator

A note on percentages: gross, not net

When your HR portal asks “what percent do you want to contribute?”, that percentage runs against your gross paycheck — the full amount you earned before taxes, FICA, and any other deductions. It does not run against your take-home pay.

A typical example: you earn $5,000 gross per pay period and elect a 10% deferral. Payroll deducts $500 (10% × gross) into the 401(k), then computes income tax and FICA on the remaining $4,500, then deducts your health insurance premium and anything else, and what’s left lands in your bank as take-home. Your employer match is calculated the same way — against the gross.

$5,000 biweekly · 10% deferral · single filer

10% of gross, not of net.

The 401(k) deferral comes off your paycheck first — before income tax, before FICA, before anything else. The percentage runs against the full amount you earned.

Source: $5,000 biweekly gross (~$130K annualized), single filer, 2026 federal rates, 5% state, $150 health-insurance premium per pay period.
  • 401(k) pre-tax $500 10.0%
  • Federal tax $450 9.0%
  • FICA $383 7.7%
  • State tax $215 4.3%
  • Insurance $150 3.0%
  • Take-home $3,302 66.0%
10% of gross $500
10% of take-home $330
Anchoring on take-home would silently undersave by $170 per paycheck — about 34% less than the same headline rate against gross. Over a career, that's a different retirement.

This is why the order of operations anchors “15% to retirement” against gross income. Anchoring on take-home would silently undersave by ~30%, since taxes and deductions can eat that much off the top.

Where the gap goes

Under-deferring for a decade has a dollar number attached. The waterfall below traces a $680K retirement shortfall — between a 22-year-old starting at 15% and a 30-year-old starting at 8% — to four specific levers. Every one of them is yours to set.

Modeled scenarios · 7% return

Late start and a low deferral rate account for $490K of the gap — the market isn't the problem.

Same return assumption, same finish line. The difference between a $1.5M and an $840K balance traces to four levers — and every one of them is yours to set.

Source: modeled scenarios — ideal at age 22, 15% deferral, 7%; actual at age 30, 8% deferral, 7%. Monthly compounding at r/12. Driver attribution illustrative.
Starting eight years earlier closes $310K of the gap — nearly half of it, before any change to how much you contribute.

The two biggest levers — when you start and how much you defer — together account for 72% of the gap. The other two (employer match and fund fees, the expense ratios on your fund choices) are smaller, but they’re under your control too. None of this depends on what the market does in any given decade. To run your own numbers, the compound growth calculator lets you change the inputs; the order of operations covers which account to fund first.

Tax advantages

Tax-deferred growth (Traditional): your money grows without being taxed each year — you only pay taxes when you withdraw in retirement.

Tax-free growth (Roth): your money grows tax-free, and qualified withdrawals in retirement are also tax-free.

Reduced taxable income (Traditional): contributions lower your current taxable income, potentially saving you money on this year’s taxes.

What you can invest in

A 401(k) is the container (a tax-advantaged wrapper) and you choose what’s inside it from the plan’s investment menu. Within a 401(k) plan, you typically have a range of investment options:

  • Mutual funds — pooled investments across many stocks or bonds. Index funds and target-date funds are common.
  • Exchange-traded funds (ETFs) — similar to mutual funds, often with lower fees.
  • Individual stocks and bonds — less common, and usually not recommended for beginners.

Getting your money out

  1. Early withdrawals (before age 59½) are generally hit with a 10% penalty plus regular income taxes. Some hardship exceptions exist.
  2. Withdrawals in retirement are taxed as ordinary income for traditional 401(k)s. Qualified Roth withdrawals are tax-free.
  3. Required Minimum Distributions (RMDs) kick in for traditional 401(k)s, currently at age 73 (rising to 75 in 2033 under SECURE 2.0, for anyone born in 1960 or later). Roth 401(k)s no longer have RMDs.

What happens when you switch jobs

If you leave your employer, you generally have a few options:

  • Leave it with your former employer’s plan (typically if the balance is over $7,000; below that, your former plan may force a cash-out, auto-rolled to an IRA from $1,000 to $7,000 or paid as a taxable check below $1,000, per SECURE 2.0).
  • Roll it into your new employer’s 401(k).
  • Roll it into an Individual Retirement Account (IRA) — see our guide to IRAs.
  • Cash it out — generally not recommended due to taxes and penalties.

Key takeaways

A 401(k) is a powerful retirement tool because of its tax advantages and the potential for employer matching. The short version:

  • If your employer matches, contribute enough to get the full match.
  • Pick traditional or Roth based on whether your tax bracket is likely to be higher now or in retirement — the Roth vs. Traditional guide walks through the framework.
  • Pay attention to fees — small differences compound over decades.
  • Don’t make impulsive changes based on short-term market moves.
Next step

Want help applying any of this to your own situation? Book a free session and bring your last paystub.