A 401(k) is the most widely used employer-sponsored retirement savings account in the United States. It allows employees to set aside a portion of their pre-tax earnings into an investment account, reducing their current taxable income and growing tax-deferred until retirement. Introduced in the late 1970s, the 401(k) has largely replaced traditional pensions in the private sector. For many Americans, it’s the primary or only vehicle for long-term retirement savings.
Understanding how a 401(k) works — its limits, tax rules, investment options and withdrawal conditions — is essential for building enough savings to replace income in retirement. Used consistently, it provides both a tax advantage and a structured way to invest over decades.
Contributions
In 2025, employees can contribute up to $23,000 to a 401(k). Those aged 50 or older can contribute an additional $7,500, bringing their total to $30,500. Contributions are made through payroll deductions and come from pre-tax income unless you opt into a Roth 401(k), which uses after-tax dollars.
Employers can also contribute, often matching a portion of what the employee contributes. A common formula is 50% of the first 6% of salary — effectively giving you an extra 3% of salary if you contribute at least 6%. Matching contributions are not taxed as income when received, and they are subject to vesting rules — you may have to stay with your employer for a certain number of years to keep them.
All contributions, including employer match, are subject to an overall limit of $69,000 in 2025, or $76,500 with catch-up.
Roth 401(k) option
Many employers now offer a Roth 401(k), which allows you to contribute with after-tax dollars. The key benefit is that qualified withdrawals in retirement are tax-free. Unlike Roth IRAs, Roth 401(k)s have no income limits for participation.
Choosing between traditional and Roth contributions depends on your current and expected future tax rates. Younger workers or those in lower tax brackets may benefit from Roth contributions. Higher earners often stick with traditional pre-tax contributions to reduce their taxable income today.
You can split contributions between both types, but the total annual limit still applies across both.
Investment options
401(k) accounts typically offer a menu of mutual funds, target-date funds, bond funds, and sometimes company stock. Some plans also allow brokerage windows, offering a wider range of investments. The plan is managed by a provider selected by the employer, and options vary depending on that provider.
Target-date funds are the default option in many plans. These automatically adjust the investment mix over time, starting with higher-risk growth assets like stocks and shifting toward lower-risk options like bonds as the target retirement year approaches.
Fees can vary significantly between plans and providers. High fees reduce long-term returns, so reviewing the plan’s expense ratios and fund options is important, especially if you’re a high contributor or nearing retirement.
Withdrawals and taxes
Withdrawals from a traditional 401(k) are taxed as ordinary income. Withdrawals before age 59½ usually incur a 10% penalty, in addition to regular income tax. There are exceptions — such as for permanent disability, certain medical expenses, or rule-of-55 early retirement withdrawals — but most early access comes with a cost.
At age 73, required minimum distributions (RMDs) begin. You must start withdrawing a minimum percentage each year, whether you need the money or not. Roth 401(k)s also currently require RMDs, although rolling them into a Roth IRA before RMD age can avoid that.
Portability and rollovers
When you leave a job, you have several options for your 401(k):
- Leave it in the old employer’s plan (if allowed)
- Roll it over into a new employer’s 401(k)
- Roll it into an IRA (traditional or Roth, depending on tax treatment)
- Cash it out (not recommended due to taxes and penalties)
Rolling over to an IRA often gives access to more investment choices and lower fees, but it also means losing certain creditor protections and loan access available in employer plans.
Loans and hardship withdrawals
Some 401(k) plans allow loans — usually up to 50% of your vested balance, up to a maximum of $50,000. Loans must be repaid with interest, and if you leave your job before repaying, the balance may be treated as a distribution and taxed accordingly.
Hardship withdrawals are allowed under specific conditions — medical expenses, home purchase, tuition, etc. These are still taxed as income and may be subject to the early withdrawal penalty, unless an exception applies.
Strategy and long-term planning
The key to making the most of a 401(k) is consistency. Contributions made over decades — especially with employer matching — grow significantly through compounding. Time in the market matters more than market timing. Setting contributions to at least the match level is the minimum; saving 10–15% of salary is often necessary to replace income in retirement.
In retirement, 401(k) income is flexible but must be managed carefully alongside other sources like Social Security, Roth IRAs, or taxable accounts. Large withdrawals can push you into higher tax brackets or affect Medicare premiums. Planning withdrawals across multiple account types allows for tax efficiency and greater income control.
Seen from Pension Gruber
Guests from the U.S. often talk about their 401(k) in two ways: either as the thing that made their retirement possible, or the account they ignored for too long. Those who contributed steadily — even modestly — usually end up with enough to travel, rest, and live without anxiety. The ones who stopped contributing, borrowed too much from it, or cashed out during job changes often mention regrets.
Most didn’t need a perfect investment strategy. They just needed to keep showing up in the contributions column. For them, the 401(k) didn’t just provide money. It provided options.
