401(k) Basics: Everything You Need to Know to Get Started

A 401(k) is one of the most powerful wealth-building tools available to American workers — and one of the most underutilized. If your employer offers a 401(k), not using it (especially if there's a match) is leaving real money on the table. Here's everything you need to know to make smart decisions about your 401(k).

What Is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan that lets you invest a portion of each paycheck into investment accounts on a tax-advantaged basis. The name comes from the section of the US tax code that created it (§401(k)).

Contributions come from your paycheck before hitting your bank account, making it the most seamless savings mechanism available. Once enrolled, saving for retirement happens automatically without any ongoing effort.

Traditional 401(k) vs. Roth 401(k)

Many employers now offer both types. Here's the difference:

Traditional 401(k):

• Contributions are pre-tax — they reduce your taxable income now
• Investments grow tax-deferred
• Withdrawals in retirement are taxed as ordinary income
• Best if you're in a higher tax bracket now than you expect to be in retirement

Roth 401(k):

• Contributions are after-tax — no immediate tax deduction
• Investments grow tax-free
• Withdrawals in retirement are completely tax-free (contributions and earnings)
• Best if you're in a lower tax bracket now than you expect to be in retirement

Many financial advisors recommend Roth 401(k) for younger workers and those earlier in their careers. If your employer offers a Roth 401(k) option and you're relatively early in your career, it's often the better choice.

2026 Contribution Limits

These limits apply to your personal contributions only. Employer matching contributions don't count toward your limit — the combined total limit (your contributions + employer contributions) is $70,000 in 2026.

Most people can't max out the 401(k) immediately. Start with whatever you can afford and increase by 1% each year, or with every raise.

The Employer Match: Free Money You Should Never Leave

If your employer offers a 401(k) match, this is the highest-priority step in your entire financial plan. The match is literally free money.

How employer matching works:

A common match structure: "50% of contributions up to 6% of salary." If you earn $60,000 and contribute 6% ($3,600), your employer adds 50% of that ($1,800). Your total retirement contribution: $5,400 — for $3,600 of your own money. That's an instant 50% return before any market gains.

Another common structure: "100% match up to 3% of salary" — contribute 3%, get 3% free.

The only right move: Contribute at least enough to capture the full employer match. Every dollar below that threshold is leaving free money on the table.

Many people lose thousands of dollars per year by contributing less than the match threshold. At $60,000 salary with a 50% match up to 6%, that's $1,800/year in employer contributions lost — $18,000 over 10 years plus the missed investment growth.

Vesting Schedules

The employer match comes with a catch: vesting. Your own contributions are always 100% yours immediately. But employer contributions may have a vesting schedule — they only become fully yours after you've worked for the company for a certain period.

Cliff vesting: 0% until a certain date (e.g., 2 or 3 years of employment), then 100% immediately.

Graded vesting: Gradually increasing ownership over 3-6 years (e.g., 20% per year until fully vested at 6 years).

Immediate vesting: Employer match is yours immediately — the most employee-friendly option.

Before leaving a job, check whether you're fully vested. Leaving before vesting means forfeiting unvested employer contributions — a potentially significant amount. This is sometimes called "golden handcuffs" because it incentivizes staying long enough to vest.

Choosing Your Investments

When you enroll in a 401(k), you must select how your contributions are invested. Most 401(k) plans offer:

Index funds (recommended): Low-cost funds tracking market indices like the S&P 500 or total market. Look for the lowest expense ratios in your plan's options. These typically appear as "S&P 500 Index," "Total Market Index," "Large Cap Index," etc.

Target-date funds: Automatically adjust their asset allocation as you approach retirement. A "Target Date 2055 Fund" for someone planning to retire around 2055 starts aggressive (mostly stocks) and becomes more conservative (more bonds) over time. Simple, automatic, reasonable. Look at the expense ratio — some target-date funds charge 0.10-0.15% (fine), others charge 0.75-1.0% (too high).

Actively managed funds: Higher expense ratios, rarely outperform their index fund equivalents over the long term. Avoid if equivalent index funds are available.

Company stock: Some plans offer your employer's stock. Don't put more than 5-10% of your 401(k) in company stock — your income already depends on your employer's health; your retirement shouldn't too.

How to choose:

1. Find all index fund options in your plan
2. Compare expense ratios — choose the lowest-cost options in each asset class
3. Allocate based on your age and risk tolerance:
   • Young investors (20s-30s): 90-100% stocks, 0-10% bonds
   • Mid-career (40s): 80-90% stocks, 10-20% bonds
   • Near retirement (50s-60s): 60-75% stocks, 25-40% bonds

If you're overwhelmed, choose the target-date fund with the year closest to your expected retirement age. It's a perfectly reasonable default.

When Can You Access the Money?

401(k) accounts are designed for retirement. Withdrawals before age 59½ generally trigger:

• Income tax on the withdrawal amount
• A 10% early withdrawal penalty

Exceptions to the penalty include:

• Separation from service at age 55 or older
• Total and permanent disability
• Certain medical expenses exceeding a threshold
• Substantially equal periodic payments (SEPP / Rule 72(t))

401(k) loans: Many plans allow borrowing up to $50,000 or 50% of the vested balance. You repay yourself with interest, which returns to your account. But: loan repayments are with after-tax dollars (and you'll pay taxes again in retirement), you're missing market gains while money is out of the account, and if you leave the job, the loan typically becomes due immediately. 401(k) loans are a last resort, not a savings vehicle.

Required Minimum Distributions (RMDs): For Traditional 401(k)s, you must begin withdrawals at age 73. RMDs are taxable income. Roth 401(k)s rolled to a Roth IRA after leaving a job have no RMDs.

What Happens When You Leave a Job?

When you leave an employer, you have four options for your 401(k):

1. Leave it with your former employer. Allowed if the balance exceeds $7,000. The investment options stay the same; you just can't contribute more.

2. Roll it to your new employer's 401(k). If your new employer accepts rollovers and has good investment options, this consolidates your accounts.

3. Roll it to an IRA. Usually the best option. Rolling to a Rollover IRA at Fidelity, Vanguard, or Schwab gives you access to a much wider range of low-cost investment options. Do a direct rollover (institution to institution) to avoid taxes and penalties.

4. Cash it out. Almost always a terrible idea. You'll owe income tax plus a 10% penalty, and you lose all future tax-deferred growth on that money. A $30,000 401(k) cashed out at a 22% tax rate costs $9,600 in taxes plus $3,000 in penalties — you net only $17,400 and lose decades of potential growth.

Increasing Contributions Over Time

A common and effective approach: increase your 401(k) contribution percentage by 1% every time you get a raise. If you get a 3% raise and increase contributions by 1%, you still take home 2% more than before. Your lifestyle barely changes, but your retirement savings grow substantially.

Many 401(k) plans have an "auto-escalate" feature that automatically increases your contribution percentage each year. Opt in to this if it's available.

The Bottom Line

Your 401(k) is the single most powerful retirement savings tool most employees have access to. The combination of pre-tax (or Roth) contributions, potential employer matching, and decades of compound growth is hard to beat.

Priority order:

1. Contribute enough to get the full employer match (do this before anything else)
2. Open a Roth IRA and contribute up to $7,000/year
3. Increase 401(k) contributions toward the $23,500 annual limit
4. Open a taxable brokerage for additional investing beyond these limits

Start with step 1 if you haven't already. If your employer matches up to 6% and you're not contributing at least 6%, change that today. It's the highest-return single financial move available to most employees.