401k:
Definition, Types, Benefits & Comparison

A 401(k) is an employer-sponsored retirement savings plan that allows employees to contribute a portion of their paycheck into a tax-advantaged investment account. Named for Section 401, subsection (k) of the Internal Revenue Code, this plan enables workers to defer compensation and invest it for retirement with special tax benefits. Employers typically offer 401(k)s as part of a benefits package to attract and retain workers.

When you participate in a 401(k), your employer automatically deducts your chosen contribution amount from each paycheck and invests it according to your selections. The money in your account can be invested in various options such as mutual funds, index funds, target date funds, and exchange-traded funds (ETFs), giving your savings a chance to benefit from compounding and grow over time.

Related terms: 403(b) plan, IRA (Individual Retirement Account), Roth 401(k), employer match, vesting

The 2 primary types of 401(k) plans are traditional 401(k) and Roth 401(k), each offering distinct tax advantages:

• Traditional 401(k): Contributions are made pre-tax, which lowers your taxable income in the year you contribute. For example, if you earn $65,000 annually and contribute $5,000, only $60,000 of your earnings gets taxed that year. Taxes are deferred until you withdraw the money in retirement, at which point distributions are included in taxable income.
• Roth 401(k): Contributions are made with after-tax dollars, meaning you pay taxes on the money before it goes into your account. However, qualified withdrawals in retirement are completely tax-free, including investment returns, as long as you are 59½ years old and have had the Roth 401(k) for at least 5 years.

Roth contributions have only been allowed starting in 2006, and the 401(k) plan sponsor decides whether to add this feature to the plan. Many employers offer both options, allowing you to diversify your tax strategy across both account types.

A 401(k) operates through automatic payroll deductions, where you decide how much of each paycheck to contribute and your employer automatically deducts this amount and invests it according to your choices. You maintain control over your investment selections from your plan's available options, which typically include index funds, mutual funds, target-date funds, and exchange-traded funds.

Your employer determines whether to offer a 401(k) as well as a contribution match. Common matching arrangements include dollar-for-dollar matches where your employer matches 100% of contributions up to a certain percentage (typically 3% to 6% of your salary), or partial matches where your employer contributes $0.50 for every dollar you contribute up to a specified limit.

Consider this example: You earn $5,000 a month and your employer offers a 50% match up to 6% of your wages. Contributing $300 monthly (6%) triggers a $150 employer match, totaling $450 in monthly retirement savings.

Starting in 2025, the SECURE 2.0 Act requires most employers to automatically enroll eligible employees into existing 401(k) and 403(b) plans at 3% to 10% contribution rates, increasing annually to a maximum of 15%.

401(k) plans offer 3 key benefits that make them one of the most popular and successful retirement saving tools:

• Automation: By automatically funneling money from your paycheck to your retirement savings, there is no opportunity to spend the money on anything else. Research confirms we're more likely to save when we don't have to think about it.
• Employer contributions: Many employers contribute to help you save for retirement, typically through a 401(k) match where your company agrees to contribute a certain amount based on what you contribute. This is essentially free money toward your retirement.
• Tax advantages: Traditional 401(k) contributions are made pre-tax, which can lower your taxable income in the year of contribution. The money saved grows and compounds more quickly because the total balance in the account isn't taxed on a yearly basis. Investment returns such as dividends or interest are not taxed as they are reinvested in the account.

The potential snowball effect of compounding makes early saving or investing particularly enticing since the earlier you start investing, the more compounded returns you can hope to make. Over time, your compound earnings could be larger than the contributions you made to your 401(k).

An employer match is an additional contribution made by your employer that depends on how much you contribute to your 401(k) plan. As part of an employee benefit package, and to encourage employees' retirement saving, an employer may offer to match a certain amount of an employee's 401(k) plan contribution.

For example, an employer might match 50 cents on a dollar of a worker's contribution up to 6% of pay. In this case, if an employee earns $50,000 and contributes 6% of pay to a 401(k) plan ($3,000), the employer would contribute 3% ($1,500) to the account, for a total contribution of 9% ($4,500).

Alternatively, an employer might decide to match dollar for dollar up to 3% of pay, in which case an employee earning $50,000 would get $1,500 in employer match for $1,500 of their own contributions. Employers can make matching contributions on an employee's Roth 401(k) plan contributions; however, the employer must allocate any matching contributions into a traditional pretax 401(k) plan account.

Vesting refers to the rights of ownership of a 401(k) plan account balance. Any funds contributed by the employee are, under the Employee Retirement Income Security Act of 1974 (ERISA), fully vested, or owned outright by the employee with no risk of forfeiture.

However, contributions made by the employer on a worker's behalf may be subject to a vesting period, which is the amount of time an employee has to work for an employer before earning the rights to the company's contributions to his or her account. Vesting schedules vary from company to company, and often phase an employee in to full ownership rights over several years.

When an employee is fully vested, it means he or she has earned the rights to all of the money an employer has contributed on his or her behalf to the 401(k) plan account. For example, a company might start contributing to an employee's 401(k) plan account right after he or she starts participating in the plan. However, if the plan has a one-year vesting requirement, the employee will only have full ownership rights in that money after being employed there for a year.

The annual employee 401(k) contribution limit is $23,500 in 2025 for those under age 50, increasing to $24,500 in 2026. If you have more than one 401(k) account, such as a traditional and a Roth 401(k), your combined contributions to both can't exceed the annual limit.

Those age 50 and older can contribute additional catch-up contributions:

• Ages 50-59 and 64+: Additional $7,500 catch-up contribution in 2025, increasing to $8,000 in 2026
• Ages 60-63: Additional $11,250 "super" catch-up contribution in 2025 if your plan allows, remaining the same in 2026

In 2026, with the SECURE 2.0 Roth requirement for high earners in effect, if you earned more than $150,000 in 2025, any catch-up contributions must be Roth, meaning you'll get no upfront tax deduction. This income threshold adjusts for inflation annually.

Most 401(k) plans have formulas built in to keep you from running over your annual maximum. If you do exceed the annual 401(k) contribution limit, you have until April 15 of the following year to withdraw the excess contributions. If you don't fix the mistake, you'll be taxed twice: once on the excess contributions in the current year and a second time upon taking withdrawals.

How much you contribute to a 401(k) depends on your personal financial situation. The general recommendation is to set your 401(k) contributions to ensure you receive at least the full employer match. Fidelity suggests aiming to contribute at least enough to get the full match amount, as this is essentially free money toward your retirement.

Beyond the employer match, aim to maximize your contributions when possible. For example, if your employer offers a 50% match up to 6% of your wages and you earn $5,000 monthly, contributing $300 monthly (6%) triggers a $150 employer match, totaling $450 in monthly retirement savings.

Generally, you must wait until you're at least age 59½ to access the money without paying a penalty. Typically, you can withdraw from a 401(k) without penalties when you're 59½ years old and have separated from your employer.

If you take a withdrawal earlier than that, you may owe a 10% penalty on top of income tax in all but a few circumstances. The SECURE 2.0 Act added new exceptions to the early withdrawal penalty for 401(k) and other retirement plans. Special exceptions that allow penalty-free early withdrawals include:

• Distributions after both reaching age 55 and separating from your employer
• Permanent disability
• Qualified medical expenses
• Higher education costs
• First-time home purchase
• Military service
• To prevent foreclosure or eviction
• Domestic abuse (SECURE 2.0)
• Emergency expenses (SECURE 2.0)
• Disaster relief (SECURE 2.0)
• Birth and adoption

Depending on where you live, you may also be taxed at the state and local levels on early withdrawals.

A required minimum distribution (RMD) is the minimum amount a person must withdraw from a 401(k) plan once that person is retired and 73 years old (this age will increase to 75 in 2033). According to the IRS, you must withdraw a certain amount of money each year starting at age 73 from traditional IRAs and workplace retirement plans, including 401(k)s.

Generally, RMDs from traditional 401(k)s begin at age 73, or April 1 of the year after you turn 73, whichever is later. One notable exception is that retirement plan account owners can delay taking their RMDs until the year in which they retire, unless they're a 5% owner of the business sponsoring the plan.

RMDs are equal to a percentage of your total eligible retirement account holdings as of December 31st the prior year and based on your life expectancy. The amount you'll be required to withdraw depends on your age and the balance in your account.

The government requires 401(k) plan participants to withdraw a minimum amount from their 401(k) plan accounts on an annual basis to ensure that participants or their beneficiaries don't avoid taxation altogether. If you do not withdraw the RMD, you will be fined up to 25% of the required amount not withdrawn and will still have to pay taxes on the taxable portion of the full RMD.

Yes, if the plan allows loans. The maximum amount an employee can borrow from a 401(k) plan generally is the lesser of 50% of the vested account balance or $50,000.

Every plan is different, but some companies only allow employees to take out loans for specific reasons. Some companies also might have specific conditions under which they will allow the loan. For example, an employer may have a minimum loan amount or a company might limit the total number of loans that can be outstanding at one time. If an employee is married, the employer may require the spouse's consent to the loan.

An employee must pay back a loan in 5 years, unless he or she uses the loan to buy a home (a principal residence). In that case, the company may extend the loan based on its own discretion. 401(k) loans are not subject to taxes or penalties (unless the employee defaults or the loan otherwise violates the loan rules), but an employee does have to pay interest on the loan. Unlike many other types of loans, the employee pays the interest to his or her plan account, not to a bank or other lender.

The main disadvantage of taking a loan is the possibility that the participant will be unable to pay it back. If an employee can't repay a loan, the money will be treated as distributed, or withdrawn. The individual will be taxed on the outstanding balance and, unless the employee is at least 59½ years old, may face an early withdrawal penalty.

Another disadvantage is that borrowing from a 401(k) may slow the growth of the account, because the money borrowed is not earning investment returns as it would in the plan. One way to avoid paying the penalty and income taxes is by taking a loan from your 401(k), which some, but not all, plans allow. Keep in mind, however, that if you take a loan, the repayments will be deducted from your paycheck, which means your take-home pay will go down.

Depending on the plan's policy, if an employee leaves a job or is fired, the employee may be required to pay back the loan right away or pay the remaining amount to an IRA or another plan as a rollover within 60 days. If you change or leave your job, you might have to repay your loan in full in a very short time frame.

A hardship withdrawal is another way an employee can access money from a 401(k) plan. Plan policies vary, but usually employees cannot withdraw more than they have contributed.

A worker must meet certain requirements to qualify for a hardship withdrawal. The hardship must be due to an immediate and heavy financial need. Under IRS rules, a need that falls under one of the categories below is deemed to be immediate and heavy:

• Buying a home or paying for certain home repairs
• Paying for education expenses such as tuition and related fees, or for those of a spouse, child, or primary beneficiary
• Preventing eviction from a primary residence
• Paying tax-deductible medical expenses that are not reimbursed to an employee, spouse, child, or primary beneficiary
• Paying for funeral expenses of a parent, spouse, child, or primary beneficiary

The amount must be necessary to satisfy the need (including that the employee can't get the money from other sources). Some plans require the employee to have exhausted all nonhardship distributions and other loans available from plans maintained by that employer.

There are several disadvantages to taking a hardship withdrawal. One of the disadvantages is that a hardship withdrawal slows a 401(k)'s growth. The money withdrawn does not earn investment returns as it would in a 401(k) plan, and in some cases, an employee can't contribute to his or her 401(k) plan until 6 months after the withdrawal.

Another disadvantage is that hardship withdrawals are taxable and may be subject to a 10% penalty if the employee is not at least 59½ years old.

You don't have to break up with your retirement plan when you and your employer part ways. You have 4 main options for what to do with old 401(k)s:

1. Cash out your earnings: This option gives you immediate access to your money. However, your funds may be subject to federal income tax, a 10% penalty for early withdrawal (if you're younger than 59½), and other state and local taxes.
2. Leave funds in your former employer's retirement plan: Your account will continue to be invested, but you won't be able to make additional contributions. If you do decide to leave money with your former employer, remember to check in on the account's performance.
3. Transfer funds into your new employer's retirement plan option: If your new plan allows it, you'll be able to continue making contributions and manage the rolled-over money and new contributions collectively.
4. Roll funds into an outside IRA: You may have more investment options through an IRA. A direct 401(k) rollover to an IRA will not incur federal income tax and earnings are tax-deferred until withdrawal.

A few other considerations as you decide which option is right for you: Account for available investment options, investment and account fees, ease of managing the accounts, and retirement account guidelines (such as loans, withdrawals, or creditor access) when making your decision. It's advisable to directly transfer funds from your former account into your new employer's plan or IRA. Indirect rollovers (where you receive the check instead of the new provider) may incur a 20% federal withholding.

Be certain to transfer pre-tax funds into pre-tax funds and Roth into Roth. If you have less than $1,000 in your account, your employer can write you a check for the balance. You'll then have 60 days to reinvest it with a new company's 401(k) plan or an IRA. After 60 days, you'll face the 10% tax penalty and income tax.

A 401(k) is often compared to 3 related retirement savings plans:

401(k) vs. 403(b) plan

Both 403(b) and 401(k) plans are tax-deferred retirement plans with similar contribution limits and tax advantages. The main difference is availability: 403(b) plans are only available to public schools, colleges and universities, nonprofit organizations that qualify as 501(c)(3)s, and churches, while 401(k) plans are offered by private-sector employers. The rules vary for each type of plan, but the main objective behind each of them is to offer workers a convenient way to save paycheck-by-paycheck in a tax-deferred retirement plan at work.

401(k) vs. 457(b) plan

457(b) plans are tax-deferred retirement plans similar to 401(k) plans but are only available to state and local governments and certain nonprofit organizations. Like 401(k) plans, 457(b) plans allow employees to defer a portion of their compensation into a retirement account with tax advantages. The main distinction is employer eligibility and some specific rule variations, though both aim to provide workers with convenient paycheck-by-paycheck retirement savings.

401(k) vs. IRA

A 401(k) is an employer-sponsored retirement plan, while an IRA (Individual Retirement Account) is a retirement account you open independently. Self-employed people can open a type of 401(k) on their own called a self-employed 401(k), and anyone who earns an income (or who is married to someone who does) can save for retirement, in addition to a 401(k) or in place of one, within an IRA. IRAs may offer more investment options than employer-sponsored 401(k) plans, but 401(k)s typically have higher contribution limits and may include employer matching contributions.