What Is a 401(k), and How Does It Work?

The short answer

A 401(k) is a retirement savings plan offered through an employer. You choose a percentage of each paycheck to contribute, the money goes into an account in your name, and you invest it among the options your plan offers. Contributions come with tax advantages, and many employers add money of their own. Like any investment account, a 401(k) can lose value, and plans charge fees that your plan’s fee disclosure explains.

Traditional or Roth contributions

Most plans offer two ways to contribute, and you can often split your savings between them:

Traditional (pre-tax): contributions come out of your pay before income tax, which lowers your taxable income now. You pay income tax on the contributions and their earnings when you withdraw them.
Roth (after-tax): contributions are taxed now, but a qualified withdrawal is tax-free, earnings included. A withdrawal is generally qualified once the account has been open at least five years and you’re 59½ or older, disabled, or it’s paid after your death.

Which suits you depends largely on whether you expect your tax rate to be higher now or in retirement. Many savers use both to keep their options open.

How much you can contribute

The IRS sets the limits each year. For 2026:

Your own contributions, traditional and Roth combined: up to $24,500 across all the 401(k)-type plans you contribute to.
Catch-up contributions at age 50 or older: up to an extra $8,000.
At ages 60 through 63, a higher catch-up applies instead: up to an extra $11,250.
Everything going into your account from you and your employer combined: up to $72,000 (or 100% of your pay, if less), before catch-up contributions.

The IRS announces the next year’s limits each fall. The 2027 limits had not been published when this guide was last reviewed, and we plan to update this guide once they are.

One rule for higher earners: if your plan allows catch-up contributions and your Social Security wages from that employer (box 3 of your W-2) were over $150,000 in 2025, any catch-up contributions you make in 2026 must go in as Roth contributions.

Employer matching and vesting

Many employers match part of what you contribute, for example 50 cents for every dollar you put in, up to 6% of your pay. Contributing at least enough to receive the full match is one of the simplest ways to add to your savings. Employer contributions may vest over several years of service, which means you earn the right to keep them over time. Your own contributions are always yours.

Taking money out

Before age 59½: the taxable portion of a withdrawal is taxed as income and, unless an exception applies, owes an additional 10% tax.
Leaving your job at 55 or later: if you separate from service during or after the year you turn 55, withdrawals from that employer’s plan aren’t subject to the 10% additional tax. This exception doesn’t apply to IRAs.
Loans and hardship withdrawals: some plans allow them, under rules that vary from plan to plan.
Required minimum distributions: you generally must begin withdrawals from a traditional 401(k) by April 1 of the year after you reach age 73, or after you retire if that’s later and your plan allows it (owners of 5% or more of the business can’t wait). For people born in 1960 or later, the starting age is 75. Roth 401(k) accounts have no required withdrawals during your lifetime.

When you change jobs

You generally have four choices for a 401(k) from a former employer:

Leave it in the old plan, if the plan allows.
Roll it into your new employer’s plan, if that plan accepts rollovers.
Roll it into an IRA, which usually offers a wider range of investments, though an employer plan may offer lower-cost funds, loans and the age 55 exception described above.
Cash it out, which generally means paying income tax, possibly the 10% additional tax, and giving up future tax-deferred growth.

Each choice has trade-offs, so compare costs, investment options and features before you move money. If an advisor recommends a rollover, ask how they would be paid on the new account. A direct rollover, where the money moves straight from one account to the other, avoids the mandatory 20% tax withholding that applies when a distribution check is paid to you.

Questions to revisit each year

Are you contributing enough to receive your employer’s full match?
Will a birthday this year make you eligible for a catch-up contribution?
Does your mix of traditional and Roth contributions still fit your tax picture?
Do your investment choices still match your timeline and comfort with risk?
Are your beneficiary designations up to date?

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Sources

This guide is for general educational purposes only and is not personalized investment, tax, or legal advice. Limits and rules change; figures reflect the published guidance available on the review date. Please consult a qualified professional about your own situation.

Rice Wealth Management Group is a registered investment adviser with the State of New Jersey Bureau of Securities and other states where required and/or exempt from registration. Registration as an investment adviser does not imply any level of skill or training.

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