401(k)

What is a 401(k)?

A 401(k) is a retirement savings plan offered by many employers. You contribute a portion of your paycheck, either pre-tax (Traditional 401(k)) or after-tax (Roth 401(k)), and your money is invested and grows tax-advantaged until you withdraw it in retirement. Many employers also add a match, which is extra money they put in based on how much you contribute.

If you're not using one, you're likely leaving money on the table. You don't need to be a Wall Street genius to make it work for you.

Key takeaways

• Time is your biggest advantage. Small contributions made in your 20s and 30s have decades to compound.
• If your employer offers a match, contribute at least enough to get all of it. It's free money for your future self.
• A Traditional 401(k) saves you taxes today. A Roth 401(k) saves you taxes later.
• High fees eat into your growth. Low-cost options like index funds help you keep more.
• Automate your contributions and raise them as your income grows. Consistency matters more than maxing out right away.

I spoke with 401(k) expert Marc Fowler about all of this on the podcast. You can listen to that conversation here.

How a 401(k) works

• It's a retirement account set up by your employer, and contributions come straight out of your paycheck.
• That money is invested, usually in a menu of funds that hold stocks, bonds, or both.
• You pay taxes either later (Traditional) or now (Roth), depending on which option you pick.

Want to compare accounts? Read the difference between a 401(k) and a Roth IRA.

The employer match

Your employer promises to match a percentage of what you contribute, up to a limit. Here's a hypothetical example: you earn $50,000 a year and your employer matches up to 3%. If you contribute $1,500 (3% of your salary), your employer adds another $1,500. That's $3,000 going into your account every year.

If you contribute less than the full match, you're walking away from part of your pay. To see what your own match is worth, try the 401(k) match calculator.

Contributions

Even 1% of your paycheck is a start. When you get a raise, bump your percentage up a little so you barely feel it.

There is an annual limit on how much you can contribute, and the IRS adjusts it most years. Check the current 401(k) contribution limit on IRS.gov. You don't need to hit the limit to benefit. The important thing is starting.

Why starting early matters

Compound growth is what happens when your returns start earning returns of their own. The longer your money is invested, the more time that snowball has to grow. (More on that in compound interest.)

Here's a hypothetical example, assuming a 7% average annual return:

• Start saving $100 a month at 25, and by 65 you'd have about $262,000.
• Wait until 35 and save twice as much, $200 a month, and by 65 you'd have about $244,000.

The late starter put in more money and still ended up with less. Returns aren't guaranteed, but time does a lot of the heavy lifting. Run your own numbers with the retirement calculator.

Traditional vs. Roth 401(k)

• Traditional 401(k): Contributions go in pre-tax, which lowers your taxable income today. Your money grows tax-deferred, and you pay income tax when you withdraw it in retirement.
• Roth 401(k): You pay taxes on contributions now, and qualified withdrawals (including the growth) are tax-free in retirement.

Both have perks. If your plan allows it, you can also split contributions between the two.

How to pick your investments

• Stocks: Higher risk and higher potential return. Good for long-term growth when you have decades to ride out the ups and downs.
• Bonds: Lower risk and lower returns. The steady part of a portfolio. (See bond.)
• Target-date funds: You pick a fund based on roughly when you plan to retire (like 2060), and it automatically shifts from stocks toward bonds over time. A solid default if you don't want to manage the mix yourself.

Watch the fees

Every fund charges an expense ratio, and small differences add up over decades. In a hypothetical example, $100,000 growing for 30 years at 7% becomes about $761,000. If a 1% fee drops that return to 6%, you'd end up with about $574,000. That fee cost roughly $187,000 in lost growth. Index funds usually have lower fees.

Diversify

Spread your money across different types of investments so one bad performer doesn't sink your whole account.

Switching jobs? What to do with your old 401(k)

• Leave it with your old employer. Your money stays invested, but you have to keep track of it, and not every plan lets you stay.
• Roll it into your new employer's plan. Keeps your retirement savings in one place. It takes some paperwork.
• Roll it into an IRA. Often more investment choices, and you manage it yourself.
• Cash it out (please don't). If you're under 59½, you'll generally owe income taxes plus a 10% early withdrawal penalty.

If you roll it over, ask for a direct rollover, where the money goes straight from the old plan to the new account. That avoids tax withholding headaches.

1. Contact your old plan administrator and ask for their rollover process.
2. Decide where the money is going: your new employer's plan or an IRA.
3. Complete the paperwork and specify a direct rollover.
4. Confirm the money arrived and pick your investments in the new account.

Don't forget about the 401(k) from three jobs ago. It's still your money.

FAQs

Can I take money out before retirement?

Technically yes, but it's expensive. Withdrawals before age 59½ are generally hit with a 10% penalty on top of regular income taxes. For example, a $10,000 withdrawal would lose $1,000 to the penalty before taxes. Some plans offer a 401(k) loan, where you borrow from your own account and pay yourself back with interest. Check whether your plan offers one.

What happens if I don't contribute enough to get the match?

You leave that money behind. Using the example above, skipping a 3% match on a $50,000 salary means missing $1,500 a year, or $15,000 over 10 years before any investment growth. If your budget is tight, aim for just enough to get the full match and build from there.

How do I check my 401(k) balance?

Log in to your plan's website or app (ask HR if you're not sure who runs your plan). You can see your balance, contributions, investments, and fees there. A monthly check-in is plenty.

What if my 401(k) is losing money?

Short-term drops are normal. If you're decades from retirement, keep contributing and focus on the long run. If you're unsure about your investment mix, use your plan's tools or advisor to reassess.

What if I don't have a 401(k) through work?

You can open an IRA at most banks or brokerages. If you're self-employed, look into a SEP-IRA or Solo 401(k).

Your 401(k) checklist

1. Enroll through HR or your benefits portal and pick a contribution percentage, even if it's just 1% to 3%.
2. Choose Traditional or Roth, or split between them if your plan allows.
3. Pick your investments. A target-date fund is a simple starting point.
4. Automate it, then raise your contribution by 1% or 2% whenever you get a raise.
5. Review once a year: balance, fees, and whether your mix still fits your goals.

Starting now, no matter how small, is what gives your money the most time to grow.