Saving for retirement can seem daunting, but employer-sponsored retirement plans, like 401(k)s, offer a structured and tax-advantaged way to build wealth over time. 401(k)s are one of the most common retirement savings vehicles. However, despite their popularity, many people don’t fully understand how they work, their tax implications, or how to maximize their benefits.

Whether you’re just starting to contribute or looking to refine your retirement strategy, understanding the key elements of a 401(k) can help you make more informed financial decisions.

A 401(k) is an employer-sponsored retirement plan that allows employees to save and invest a portion of their earnings while enjoying tax benefits. The plan gets its name from the section of the tax code that established it. Employers offer 401(k) plans as part of their benefits packages, often using them as an incentive to attract and retain employees.

Not all workers have access to a 401(k). Some industries offer similar plans, such as:

• 403(b) Plans: Typically offered to employees of public schools, non-profits, and religious organizations.
• 457(b) Plans: Designed for government employees and certain non-profit workers.
• Solo 401(k)s: Available to self-employed individuals and small business owners without employees.

For those who don’t have access to an employer-sponsored plan or want additional retirement savings, an individual retirement account (IRA) is another option. IRAs offer tax advantages similar to 401(k)s but have lower contribution limits.

When you enroll in a 401(k), you choose a percentage of your paycheck to be automatically contributed to your retirement account. These contributions are then invested in various funds, such as mutual funds, index funds, and target-date funds.

One of the biggest advantages of a 401(k) is compounding growth—the ability of your investments to generate earnings, which are then reinvested to generate even more earnings. The earlier you start contributing, the more time your money has to grow.

There are two main types of 401(k)s, each offering different tax advantages:

• Traditional 401(k) – Contributions are made pre-tax, which reduces your taxable income for the year. The money grows tax-deferred, meaning you won’t pay taxes until you withdraw it in retirement.
• Roth 401(k) – Contributions are made after-tax, so while you don’t get an immediate tax break, withdrawals in retirement (including earnings) are tax-free as long as the account has been open for at least 5 years.

Choosing between a traditional and a Roth 401(k) depends on your current and expected future tax situation. Some people contribute to both to diversify their tax liabilities.

One of the biggest benefits of a 401(k) is that many employers offer matching contributions—essentially free money added to your retirement savings. Matches vary but often follow these structures:

• Full Match: An employer matches 100% of your contributions up to a certain percentage of your salary (e.g., dollar-for-dollar up to 5%).
• Partial Match: An employer contributes a fraction of what you contribute (e.g., 50% of your contributions up to 6% of your salary).

Some employer plans will come with certain vesting schedules.

Each year, the IRS sets limits on how much you can contribute to a 401(k). For 2025, the limits are:

• Under 50: $23,500
• 50-59 and 64+: $31,000 (includes a $7,500 “catch-up” contribution)
• 60-63: $34,750 (includes a $11,250 “super catch-up” contribution)

If you contribute to both a traditional and a Roth 401(k), the combined limit is still the same. If you accidentally exceed the limit, you have until April 15 of the following year to withdraw the excess to avoid double taxation.

To encourage long-term saving, the government imposes restrictions on when and how you can withdraw funds from your 401(k):

• Before age 59.5: Withdrawals are subject to income tax plus a 10% penalty unless an exception applies. Exceptions include financial hardship (such as medical expenses or foreclosure), total disability, or separating from your employer at age 55 or older.
• Loans: Some plans allow you to borrow against your 401(k), typically up to $50,000 or 50% of your vested balance. However, if you leave your job before repaying the loan, the remaining balance may become taxable and subject to penalties.
• After age 59.5: Withdrawals are taxed as regular income (for traditional 401(k)s), but no penalty applies.

Once you reach age 73, or 75, depending on date of birth, the IRS requires you to start withdrawing a portion of your 401(k) each year. RMDs are based on your account balance and life expectancy. If you fail to take an RMD, you could face a 25% penalty on the amount not withdrawn.

One exception: If you’re still working and don’t own more than 5% of the company, you may be able to delay RMDs until retirement.

Leaving a job doesn’t mean you lose your 401(k). You have several options:

• Leave it with your former employer: Some plans allow you to keep your funds in the old plan. However, you can no longer contribute, and investment options may be limited.
• Roll it into a new employer’s 401(k): This option consolidates your retirement savings into one account.
• Transfer it to an IRA: An IRA rollover gives you more investment choices and flexibility.
• Cash it out: While tempting, this is the least favorable option since you’ll owe taxes and possibly a 10% early withdrawal penalty.

A 401(k) is a powerful tool for building long-term wealth, offering tax advantages, employer contributions, and investment growth through compounding. Understanding how your plan works—and taking full advantage of benefits like employer matching and tax-deferred growth—can make a significant difference in your retirement readiness.

Whether you’re just getting started or optimizing your savings strategy, consistently contributing and making informed decisions about your 401(k) can help you achieve a secure and comfortable retirement.

Important Disclosure: This material is for informational purposes only and should not be construed as investment, tax, or financial planning advice. Individuals should seek professional guidance to determine the best approach for their specific circumstances.