A 401k is the most common retirement savings plan offered by employers in the United States. If your company offers one, it is likely your best tool for building retirement wealth. In this comprehensive guide, we will explain how 401k plans work and how to maximize your savings.
What is a 401k?
A 401k is a retirement savings plan sponsored by your employer that allows you to save and invest a portion of your paycheck before taxes are taken out. Your money grows tax-deferred until you withdraw it in retirement. Many employers also match a portion of your contributions, essentially giving you free money.
The simple version: A 401k lets you save for retirement directly from your paycheck with tax benefits. If your employer matches contributions, you get free money on top of what you save.
How a 401k Works
- You contribute: Choose a percentage of your paycheck to defer into your 401k
- Employer may match: Many employers contribute additional money based on your contributions
- Tax benefits: Traditional 401k contributions reduce your taxable income
- Invest the money: Choose from your plan's investment options
- Grow tax-deferred: No taxes on gains until you withdraw
- Withdraw in retirement: Pay income tax on withdrawals after age 59 1/2
401k Contribution Limits 2026
The IRS sets annual limits on how much you can contribute to your 401k:
Employee Contribution Limits
- Under age 50: $23,500 per year
- Age 50-59: $31,000 per year ($7,500 catch-up contribution)
- Age 60-63: $34,750 per year ($11,250 super catch-up contribution)
- Age 64 and over: $31,000 per year
Total Contribution Limit (Employee + Employer)
- Under age 50: $70,000 per year
- Age 50 and over: $77,500 per year
Example: Maximizing Your 401k
Rachel is 35 and earns $80,000. Her employer matches 50% of contributions up to 6% of salary.
- Rachel contributes 6% = $4,800/year
- Employer matches 50% = $2,400/year
- Total annual contribution = $7,200
- That is a 50% instant return on her money from the match alone
The Power of Employer Matching
Employer matching is one of the best benefits available to workers. It is essentially free money added to your retirement savings.
Common Matching Formulas
- Dollar-for-dollar up to 3%: Contribute 3%, employer adds 3%
- 50 cents on the dollar up to 6%: Contribute 6%, employer adds 3%
- 100% match up to 4%: Contribute 4%, employer adds 4%
Critical rule: Always contribute at least enough to get the full employer match. Not doing so is leaving free money on the table. A 50% match is an immediate 50% return on your investment that no other investment can guarantee.
Traditional vs Roth 401k
Many employers offer both Traditional and Roth 401k options. The choice affects when you pay taxes.
Traditional 401k
- Contributions are pre-tax (reduce taxable income now)
- Money grows tax-deferred
- Pay income tax on withdrawals in retirement
- Best if you expect lower tax rates in retirement
Roth 401k
- Contributions are after-tax (no tax deduction now)
- Money grows tax-free
- Withdrawals in retirement are tax-free
- Best if you expect higher tax rates in retirement
Example: Traditional vs Roth 401k
David earns $70,000 and contributes $10,000 to his 401k.
- Traditional 401k: Taxable income becomes $60,000. He saves $2,200 in taxes now (22% bracket). Pays taxes when he withdraws in retirement.
- Roth 401k: Taxable income stays $70,000. He pays $2,200 more in taxes now. All future withdrawals are tax-free, including decades of growth.
401k Investment Options
Most 401k plans offer a limited menu of investment options. Understanding your choices is essential.
Common 401k Investment Types
- Target-date funds: All-in-one funds that automatically adjust based on your retirement date
- Index funds: Low-cost funds tracking market indexes like the S&P 500
- Actively managed funds: Funds where managers try to beat the market
- Bond funds: Fixed-income investments for stability
- Company stock: Shares in your employer (use caution, limit exposure)
- Stable value funds: Low-risk options similar to money markets
Building Your 401k Portfolio
A simple approach for most investors:
- Option 1: Choose a target-date fund matching your expected retirement year
- Option 2: Build a three-fund portfolio with US stocks, international stocks, and bonds
401k Withdrawal Rules
Understanding withdrawal rules helps you plan and avoid penalties.
Standard Withdrawals
- Age 59 1/2 or older: Withdraw without penalty, pay income tax
- Before 59 1/2: 10% early withdrawal penalty plus income tax
- Rule of 55: Leave job at 55 or older and access that employer's 401k penalty-free
Required Minimum Distributions
You must begin taking RMDs from your 401k at age 73. If you are still working at the company, you may be able to delay RMDs until retirement.
Hardship Withdrawals
Some plans allow early withdrawals for hardships like medical expenses, home purchase, or education. You still pay taxes and the 10% penalty in most cases.
401k Loan Option
Many 401k plans allow you to borrow from your account. While this can be useful in emergencies, it comes with risks.
401k Loan Basics
- Maximum loan: Lesser of $50,000 or 50% of vested balance
- Repayment: Usually 5 years (longer for home purchase)
- Interest: You pay interest to yourself
Risks of 401k Loans
- Missing out on market growth while money is out of the account
- If you leave your job, the loan may become due immediately
- Unpaid loans become taxable distributions with penalties
What Happens When You Leave Your Job
When you change employers, you have several options for your 401k:
- Leave it: Keep the money in your old employer's plan
- Roll over to new 401k: Transfer to your new employer's plan
- Roll over to IRA: Transfer to a Traditional or Roth IRA (often best for more options)
- Cash out: Take the money (triggers taxes and penalties, usually not recommended)
Rollover tip: Always do a direct rollover where the money transfers directly between accounts. Indirect rollovers have 20% tax withholding and strict 60-day rules.
401k Strategies for Maximum Growth
1. Get the Full Employer Match
This is the minimum. Never leave free money on the table.
2. Increase Contributions Over Time
Increase your contribution rate by 1% each year. You will hardly notice the difference in your paycheck.
3. Choose Low-Cost Index Funds
Expense ratios matter. A 1% difference in fees can cost you hundreds of thousands over your career.
4. Rebalance Annually
Review your portfolio once a year and rebalance to maintain your target allocation.
5. Consider Both Traditional and Roth
Contributing to both creates tax diversification for retirement flexibility.
Track Your 401k Performance
Pro Trader Dashboard helps you monitor your 401k investments, track employer matching, and visualize your retirement savings growth.
Summary
A 401k is one of the most powerful retirement savings tools available. The combination of tax benefits, employer matching, and automatic payroll deductions makes it easier to build wealth over time. Always contribute at least enough to get the full employer match, choose low-cost investments, and let compound growth work for you over the decades.
Ready to learn more? Explore our guides on Roth 401k plans and target-date funds.