401(k) Basics: Your Complete Guide to Retirement Savings

What Is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan that allows you to contribute a portion of your paycheck before taxes are taken out. The money grows tax-deferred until you withdraw it in retirement, typically after age 59½.

Named after the section of the IRS tax code that created it, the 401(k) has become the most popular retirement savings vehicle in America, with over 60 million active participants.

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

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

Not sure which to choose? Many financial advisors recommend splitting contributions between both to hedge your bets on future tax rates.

2026 Contribution Limits

The IRS sets annual limits on how much you can contribute to your 401(k):

Employer Matching: Free Money

Many employers match a portion of your 401(k) contributions—this is essentially free money that you should never leave on the table.

Common Matching Formulas

• Dollar-for-dollar up to 3%: Contribute 3% of salary, employer adds 3%
• 50 cents on the dollar up to 6%: Contribute 6%, get 3% match
• Tiered matching: 100% on first 3%, 50% on next 2%

Example: The Power of Matching

If you earn $60,000 and your employer matches 50% up to 6% of your salary:

Vesting Schedules

Your own contributions are always 100% yours, but employer matching may be subject to a vesting schedule—meaning you only own a percentage until you've worked there long enough.

Common Vesting Types

• Immediate vesting: Employer match is yours right away
• Cliff vesting: 0% until year 3, then 100% at once
• Graded vesting: 20% per year over 5-6 years

Check your plan documents to understand your vesting schedule before changing jobs—you might be close to a vesting milestone.

Investment Options

Most 401(k) plans offer a menu of investment options. Understanding your choices is crucial:

Target-Date Funds (Easiest Option)

Pick a fund based on your expected retirement year (e.g., Target 2050 Fund). The fund automatically adjusts from aggressive to conservative as you age. Great for hands-off investors.

Index Funds (Low-Cost Option)

Funds that track market indexes like the S&P 500. They have very low fees (often 0.03-0.10%) and historically outperform most actively managed funds.

Build Your Own Portfolio

A simple approach is the "three-fund portfolio": total U.S. stock index, total international stock index, and total bond index. Adjust percentages based on your age and risk tolerance.

Common 401(k) Mistakes to Avoid

1. Not Contributing Enough for the Match

This is the most expensive mistake. If your employer offers matching, not contributing enough is literally turning down free money.

2. Cashing Out When Changing Jobs

If you cash out your 401(k) before age 59½, you'll pay income taxes PLUS a 10% early withdrawal penalty. A $50,000 balance could shrink to $30,000 or less. Instead, roll it into an IRA or your new employer's plan.

3. Taking 401(k) Loans

While technically an option, 401(k) loans remove money from the market, potentially costing you years of compound growth. If you leave your job, the loan often becomes due immediately.

4. Ignoring Fees

A 1% difference in fees might not sound like much, but over 30 years it can cost you hundreds of thousands of dollars. Choose low-cost index funds when available.

5. Being Too Conservative Early On

If you're in your 20s or 30s, having too much in bonds or stable value funds means missing out on decades of stock market growth. Time is your biggest advantage—use it.

Required Minimum Distributions (RMDs)

Starting at age 73 (as of 2023), you must begin taking required minimum distributions from your traditional 401(k). The amount is based on your account balance and life expectancy. Roth 401(k)s are also subject to RMDs, though Roth IRAs are not.

401(k) vs. IRA: What's the Difference?

Action Steps to Maximize Your 401(k)

1. Check your current contribution rate and make sure you're getting the full employer match
2. Review your investment options and consider low-cost index funds or an age-appropriate target-date fund
3. Increase your contribution by 1% each year until you hit the maximum
4. Check your beneficiary designation and update it after major life events
5. Review your vesting schedule if you're considering changing jobs