A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute pre-tax income, reducing current taxable income. Many employers match a percentage of contributions.
How a 401(k) Works
Contributions are deducted from your paycheck before income tax, lowering your taxable income immediately. The money grows tax-deferred until withdrawal in retirement, when it is taxed as ordinary income. For 2025, the contribution limit is $23,500 ($31,000 if age 50+).
Many employers offer a match — for example, matching 50% of your contributions up to 6% of salary. This is essentially free money with an instant 50% return.
Why 401(k)s Matter
The employer match makes 401(k)s the highest-ROI investment most people have access to. Not contributing enough to get the full match is leaving free compensation on the table. The tax deferral also means your money compounds on a larger base since taxes are postponed.
Real-World Example
Salary: $80,000. You contribute 6% ($4,800/year). Employer matches 50% ($2,400/year). At 7% annual return over 30 years, your 401(k) grows to $681,537 — of which $72,000 was your employer's free money.
Frequently Asked Questions
What happens to my 401(k) if I leave my job?
Your contributions and vested employer matches stay yours. You can leave the money in the old plan, roll it into your new employer plan, roll it into an IRA, or cash it out (with taxes and penalties if under 59½).
Should I choose Traditional or Roth 401(k)?
Traditional 401(k) reduces your taxes now; Roth 401(k) provides tax-free withdrawals later. If you expect to be in a higher tax bracket in retirement, Roth may be better. Many advisors recommend splitting contributions.
How much should I contribute to my 401(k)?
At minimum, contribute enough to get the full employer match. Aim for 15% of income (including match) for retirement savings. If that is not feasible, start with the match and increase by 1% each year.