What Is a 401(k) Plan?
(4 of 9)
What Is a 401(k) Plan?
A traditional 401(k) plan is a retirement savings and investment plan offered by employers to their employees. Many employers like it because it costs less than a traditional pension plan; many employees like it because it can be more lucrative and gives them more control over their retirement income.
Things To Know
- 401(k) money is portable—you take it with you even if you change jobs.
- You can usually invest your 401(k) in many different types of investments.
- When an employer matches your contributions, it’s free money for you.
How the 401(k) works
With a 401(k) plan, you can take a portion of the cash your employer would have paid you in wages and choose instead to contribute it to a tax-qualified retirement account, set up according to rules in section 401(k) of the tax code. You contribute the funds pre-tax, so you don’t have taxes withheld on the portion of your income contributed. As a benefit of employment, many employers will match anywhere from 1 to 100 percent of your contribution to a 401(k) plan.
Funding options
Most plans allow you to invest in many different kinds of instruments: different kinds of stock and bond mutual funds, money market funds, and guaranteed investment funds that pay a pre-set interest rate. You determine what portion of your contribution goes to each fund, and many plans let you transfer money among funds.
Your money is portable
Unlike traditional pensions, 401(k) money is portable—you take it with you even if you change jobs. Funds you withdraw are taxed at regular income tax rates. But there are severe restrictions and/or a 10 percent tax penalty on withdrawals before retirement (unless certain exceptions apply).
Many plans do allow the option to borrow from your funds without taxation, as long as you pay the money back in a prescribed manner.
Variations on the 401(k)
The 401(k) is a versatile retirement plan that can be offered in the form of a starter 401(k), a solo 401(k) for the self-employed, or a SIMPLE 401(k). Each of these varieties is designed with different needs in mind for employees.
Employees of qualifying non-profit institutions may have a variation of this plan called a 403(b) plan. Non-profit employees who want to participate in a plan other than the one offered by their company can set up a 403(b)-7 account with virtually any company offering mutual funds.
Like many other retirement plans, the 401(k) is also available in the Roth version.
How to get free money from your employer
If your company offers a 401(k) plan—especially one with an employer matching contribution—it will be worth your time to learn about it. An employer "match" is essentially free money, and employees are wise to take advantage of it by contributing at least enough to secure maximum employer matching funds, if possible. Even without an employer contribution, the 401(k) is a great opportunity to build resources for your retirement, and the automatic nature of your salary reduction contributions makes it nearly painless.
Automatic enrollment
Companies are allowed by law to automatically enroll employees in defined-contributions plans such as 401(k)s. Employees may opt out of that if they wish.
Contribution limits
Total contributions (employee and employer) are limited to the lesser of 100 percent of the employee’s compensation or $70,000 for 2025. Employer contributions are not required, however, so employers have flexibility in matching their employees’ contributions. The maximum employee contribution is $23,500 for 2025. A "catch-up" provision of the law allows taxpayers over age 50 to contribute an additional $7,500, and another one effective in 2025 allows individuals age 60 to 63 to contribute a maximum catchup of $11,250 instead.