The 401(k) is one of the most popular retirement savings tools. Many employers offer this type of plan, helping their workers save for the future in a tax-advantaged way. If you’re currently saving in a 401(k) or are considering doing so in the future, keep reading to learn more about how these accounts work, rules to be aware of, and your other retirement savings options. 

What is a 401(k) plan?

A 401(k) plan is a qualified retirement plan that’s offered by many private-sector employers in the United States. It’s named after the section of the Internal Revenue Code that authorizes it. It allows workers to defer a portion of their current wages and invest those dollars for retirement.  

401(k) plans offer several key advantages, including short-term and long-term tax savings. However, they also come with several restrictions in terms of their contribution limits and withdrawals. 

How a 401(k) works

A 401(k) allows workers to defer a certain portion of their current wages into a tax-advantaged retirement account. There are two types of contributions that can be made to a 401(k) plan, each of which has a different tax advantage: 

• Traditional 401(k): A traditional 401(k) contribution contribution offers an upfront tax advantage. The dollars you contribute to your 401(k) are tax-deferred, meaning you won’t pay current income taxes on that portion of your income. Your taxable income is reduced by each dollar you put into the plan. When you take plan withdrawals, you’ll pay income taxes on those dollars. This type of 401(k) contribution may be suited to investors with higher incomes who would benefit most from the immediate tax advantage.
• Roth 401(k): A Roth 401(k) contribution offers no upfront tax advantage. When you contribute to the plan, you do so with after-tax dollars. However, your Roth 401(k) withdrawals are tax-free as long as current requirements are met. So, while you didn’t enjoy an upfront tax advantage, you’ll keep 100% of your distributions during retirement. This type of 401(k) contribution may be best suited to investors with lower incomes who don’t necessarily need the upfront tax advantage today and may benefit more from it in the future. 

Once you’ve contributed money to your 401(k), you’ll be able to invest those dollars in options selected by the plan sponsor. By doing this, you’ll be able to potentially grow your savings exponentially for retirement. 

401(k) plans are subject to some strict withdrawal rules, which we’ll discuss in a later section. Generally speaking, because these accounts are designed to help workers save for retirement, there are tax and financial penalties for withdrawing money early. 

Read more: Tips for understanding your 401(k) plan

How do you invest in a 401(k)?

Because a 401(k) is a workplace retirement plan, the only way to invest is by working for a company that offers one. The good news is that roughly 73% of private employers offer defined contribution retirement plans like the 401(k), so a majority of private sector workers will have access to one.¹

Generally speaking, your employer must allow you to contribute to and invest in the company 401(k) if you’re at least 21 and have been with the company for at least one year (or two years, in certain situations). However, many employers have less restrictive eligibility.²

When employers establish a 401(k) plan, they choose a plan provider. They also choose a menu of investment options that employees may choose from. And when you set up your plan contributions, you’ll designate how you’d like those dollars invested, choosing from the investment options in the plan. 

401(k) investment options may include mutual funds, collective investment trusts and stable value funds.

One of the most popular investment choices in 401(k) plans is a target-date fund. These funds allow workers to access a diversified portfolio of assets with just one investment. Each target-date fund corresponds to a particular retirement year. The fund invests in a diversified selection of stocks and bonds. As it nears the designated retirement year, the fund is automatically rebalanced to become more conservative and help reduce its risk. 

Contribution limits

Each year, the IRS sets a maximum contribution limit for participants. The limit generally increases every year or every few years based on inflation. 

In 2025, workers may contribute up to $23,500 dollars to their company’s 401(k) plan.³

Employees 50 or over may also make a catch-up contribution of $7,500. The IRS is also raising the catch-up contribution limit for individuals aged 60 to 63, who will be able to add an additional $3,750 to their 401(k) plans on top of the $7,500. 

In many cases, an employee’s contributions are based on a percentage of their salary. For example, someone might set up their contributions so that 10% of their salary is automatically withheld from their paycheck and deposited into their 401(k) plan. 

If your goal is to max out your 401(k) plan for 2025, it’s important to run the numbers to determine how much you must contribute. You can contribute the maximum of $23,500 by doing any of the following:

• $1,958.33 per monthly paycheck
• $979.17 per twice-monthly paycheck 
• $903.85 per bi-weekly paycheck 

In addition to the individual contribution limit, there’s also an overall limit on contributions, which applies to employee deferrals and employer matching contributions. The overall contribution limit for 2025 is either $70,000 or 100% of an employee’s compensation, whichever is lower.⁴ 

Read more: 401(k) contribution limits for 2024

401(k) employer matching

It’s not only individuals that can contribute to their company’s 401(k) plan to save for their retirement. Employers can also make contributions for their employees. 

Importance of employer contributions

Employer contributions are incredibly beneficial for workers because they allow them to save more for retirement each year.

If your employer offers a matching contribution, it’s a part of your compensation package. Not only will it result in hundreds or thousands of dollars more in your 401(k) account each year, but it can make the difference of hundreds of thousands of dollars by the time you retire. For that reason, it’s important to make the minimum contribution required to earn your full employer match, if possible. 

Read more: What is 401(k) matching and how does it work?

Types of 401(k) employer contributions

Each company can structure its 401(k) employer contributions in the way that best suits them. Here are some of the most common types of employer contributions: 

• Partial match: A partial match is when an employer agrees to match a certain percentage of your contributions — often 50% — up to a specific percentage of your salary — often 6%. For example, let’s say you earn $100,000. You contribute 6% of your compensation to your 401(k) plan, and your employer matches 50% of your contributions on the first 6% of your compensation. You would contribute $6,000 per year, while your employer would contribute $3,000.
• Dollar-for-dollar match (100% match): Some companies offer a full match on your retirement contributions, up to a particular percentage of your compensation. For example, using the same information in our example above but with a 100% match, you and your employer would each contribute $6,000 per year to your 401(k) account.
• Non-elective contribution: Some companies offer an employer contribution that’s entirely separate from the employee deferrals. Employees would receive these contributions regardless of whether or how much they contribute to their own plan. Like matching contributions, these non-elective contributions are generally a percentage of compensation.

Withdrawing from your 401(k)

Because 401(k) plans are designed for retirement savings, the IRS puts strict limitations in place on when someone can withdraw money and what penalties they face for early withdrawals.

Overview of withdrawal rules

To take a 401(k) distribution, one of the following must generally be true:

• You die, become disabled, or otherwise leave your job
• The plan is terminated and isn’t replaced with a new one
• You reach age 59 ½ or face financial hardship

To qualify for a hardship distribution, you must have an immediate and heavy need, and you withdraw only the amount necessary to satisfy that need.

If you withdraw from or cash out a 401(k) plan before age 59 ½, you’ll pay a 10% early withdrawal penalty on your distribution (unless an exception applies). For example, if you withdraw $10,000, you’ll pay $10,000 in penalties — and that’s on top of any applicable income taxes. Even a hardship distribution doesn’t exempt you from this penalty.

Early withdrawal exceptions

Early 401(k) withdrawals are subject to a 10% early withdrawal penalty in addition to the required income taxes. However, the IRS offers a few exceptions that allow you to withdraw funds without paying this penalty. However, you’ll still pay any applicable income taxes. Here are those exceptions: 

• You die or become totally and permanently disabled
• You take corrective distributions as a result of excess contributions
• You withdraw up to $5,000 per child for qualified adoption expenses
• You withdraw up to $22,000 after you sustain an economic loss due to a federally declared disaster
• You’re the victim of domestic abuse and withdraw the lesser of $10,000 or 50% of your account
• You’re required to pay someone else under a Qualified Domestic Relations Order
• You withdraw up to $1,000 for a personal or family emergency
• You take a series of substantially equal payments
• There’s an IRS levy on your plan
• You pay for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI)
• You’re a qualified military reservist and are called to active duty
• You separate from service during or after the year you turn 55
• You’ve been diagnosed with a terminal illness

401(k) loan

If you aren’t eligible to or would prefer not to take a 401(k) distribution, you can take a loan if allowed by your plan. You’ll generally have to repay the loan within five years in substantially level payments.

There are some risks of a 401(k) loan. First, because you’ve taken money out of the account, it no longer has growth potential. Next, if you don’t repay the loan on time, it will be considered a distribution and will be subject to taxes and possibly penalties. Finally, if you leave your job, whether voluntarily or not, you may be required to repay the full amount immediately to avoid tax and penalties. 

Required minimum distribution (RMD)

The IRS requires all workers to start taking distributions from their traditional retirement accounts — but not Roth accounts — when they reach age 73 if you’re no longer working. These are known as required minimum distributions (RMDs). The amount you’re required to withdraw depends on your retirement account balance and your life expectancy. The IRS provides tables to help you determine how much you must withdraw, but it may be worth working with a financial professional to ensure you don’t withdraw too little.

If you don’t take your RMD, you’ll pay a penalty of 25% of the amount you didn’t distribute as required. 

Understanding 401(k) rollovers

When you leave a job, you’ll have a few different options as to what to do with the money, including rolling it over into either a new 401(k) plan or an individual retirement account (IRA). 

Benefits of 401(k) rollovers

A 401(k) rollover has several potential benefits. First, when you leave a job, rolling over your 401(k) allows you to help keep track of your retirement savings and to consolidate it all into one place. This can be far simpler than having several different retirement accounts scattered about and trying to keep track of all of them.

Rolling over your 401(k) can also give you more control over your investments. You can decide whether to roll over into a new 401(k) or an IRA. And if you choose an IRA, you’ll have full control over your financial institution, investment options, and more. 

Options for rolling over a 401(k)

You can choose to roll your 401(k) balance over into either a new 401(k) plan or into an IRA. Regardless of which option you choose, you’ll be able to choose between either a direct or indirect rollover: 

• Direct rollover: This type of rollover is the simplest to complete. You’ll contact your plan sponsor and ask them to send your current plan balance payable directly to your new plan. No taxes are withheld from the transfer amount.
• Indirect rollover: When you choose an indirect rollover, your current plan sends a check payable to you in the amount you plan to roll over. Your plan will withhold 20% in federal taxes and possibly state taxes from the balance. Additionally, you’ll have 60 days to deposit the money in your new account, and if you fail to do so, it will be considered a taxable withdrawal.

Considerations before rolling over 401(k)

When considering whether to roll over your 401(k) plan and where to roll it over, there are a few things to consider.

First, consider the cost of the various plans available. Compare the plan fees between your current 401(k) plan and your new one. Additionally, compare both of those amounts to the fees you’d pay by investing on your own in an IRA.

Another thing to consider is the investment options available. Generally speaking, an IRA may provide a far greater selection of investments to choose from. You can choose any investment offered by your financial institution, while a 401(k) only allows you to choose from the investment menu chosen by the plan sponsor.

Some people may decide it’s better to leave the money in their current employer’s 401(k) — though not all employers allow this option. Others may decide to roll the balance over to either a new 401(k) plan or an IRA. Only you can decide which is the best option for you.

Consider all your options and their features and fees before moving money between accounts. 

Other types of retirement accounts

A 401(k) plan is the most popular type of retirement plan, especially among private-sector workers. However, there are plenty of other plan types to choose from. Some of these are employer-sponsored plans, while others are individual plans designed for either employees or self-employed individuals.

• Traditional or Roth IRA: An IRA is a type of retirement account that individuals may set up for themselves outside of their employer. Like 401(k) plans, IRAs can be either traditional or Roth accounts. They have considerably lower contribution limits, at only $7,000 in 2025.⁵
• 403(b) plan: A 403(b) plan is a retirement plan offered by certain public schools, churches, and charitable organizations. They have the same contribution limits as 401(k) plans and can be either traditional or Roth accounts. 
• 457(b) plan: A 457(b) plan is a retirement plan offered by certain state and local government entities. They have the same contribution limits as 401(k) plans and can be either traditional or Roth accounts. .
• SEP IRA: A Simplified Employee Pension (SEP) IRA allows business owners to save for retirement on behalf of themselves and their employees. Though SEP IRAs are available to businesses of any size, it is best suited to businesses with no or few employees because the employer must contribute equally for all employees, and there are no employee contributions. The contribution limit is $70,000 or 25% of an employee’s compensation, whichever is lower.⁶
• SIMPLE IRA: A Savings Incentive Match Plan for Employees (SIMPLE) IRA allows small business owners and their employees to save for retirement. Employees may contribute up to $16,500 per year, while employers may contribute either a 2% non-elective contribution or a 3% matching contribution.⁷
• Solo 401(k): A solo 401(k), also known as a one-participant 401(k), is technically a type of 401(k). However, it can only be used by companies where either the business owner or the owner and their spouse are the only employees. It has the same contribution limits as the normal 401(k), but with certain rules for the employer portion of contributions.

401(k) FAQs

Do I have to enroll in a 401(k) plan?

If your employer offers a 401(k) plan, you aren’t required to participate. However, some companies have automatic enrollment for their 401(k) plans, in which case you’ll have to manually opt out. 

Should I contribute to a 401(k) even if I have an IRA?

Even if you invest in an IRA, it still may be advantageous to contribute to your company’s 401(k). Many companies offer an employer match for 401(k) contributions. If your employer offers matching contributions, it’s likely worth contributing at least enough to earn your full match. 

How much should I contribute to my 401(k)?

Experts generally recommend saving between 10% and 15% of your income for retirement. If that isn’t feasible right now, contribute as much as you feel comfortable — ideally enough to get your full employer match — and consider increasing your contributions as your income grows. 

Should I max out my 401(k)?

Maxing out your 401(k) can help set you up for a comfortable retirement, and in a perfect world, everyone would be able to do so. However, given the $23,500 contribution limit for 401(k)s, many people won’t be able to max out their account. In that case, simply contribute as much as you comfortably can. 

What happens to my 401(k) account when I leave my job?

If you leave a job, you can either leave your 401(k) with your old employer, roll the money into a new 401(k) plan or an IRA, or cash out the plan. However, not all companies allow you to keep your 401(k) with them after you’ve left your job, and there are tax penalties for cashing out your 401(k) before age 59 ½ (except under exceptions as noted above). 

What is a 401(k) recordkeeper?

A 401(k) recordkeeper is the party responsible for keeping the books on all plan assets, including who participates in the plan, and how much is in their account. The recordkeeper is often a third-party vendor, such as a payroll company or a financial institution.