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

Short answer: a 401(k) is an employer-sponsored retirement account. You choose a percentage of each paycheck to invest, usually in funds offered by the plan, and many employers add a match. Traditional 401(k) contributions come out before tax and reduce your taxable income, and you pay tax when you withdraw; Roth 401(k) contributions are taxed now and qualified withdrawals are tax-free. The first rule is to contribute at least enough to get the full employer match.

Key takeaways

• A 401(k) is invested money, so it grows with the funds you pick, not with a fixed rate.
• An employer match is part of your pay. Skipping it leaves money behind.
• Check the vesting schedule: you may not keep the full match if you leave early.
• Withdrawing before age 59 and a half generally brings tax and a 10% penalty, with exceptions.

How does a 401(k) work?

1. You enrol and pick a contribution percentage, taken from each paycheck automatically.
2. The money is invested in the funds you choose from the plan's menu, often including target-date and index funds.
3. Your employer may add a match based on a formula.
4. Growth builds inside the account. You do not pay tax on it each year.
5. You withdraw in retirement, and the tax treatment depends on whether it is traditional or Roth.

How does the employer match work?

A common formula is 50 cents for each dollar you contribute, up to 6% of your pay. Here is the effect on a $60,000 salary:

The match stops at 6%, so contributing 10% earns no extra match, though it still builds your savings. Contributing 6% means $450 a month goes in. Over 30 years at an assumed 7%, that grows to about $548,987, compared with about $365,991 for the $300 a month you would put in without the match. The match alone is worth about $182,996 in this example. Always read your plan's formula, because they differ.

What is vesting?

Your own contributions are always yours. The employer match may vest over time: with a cliff schedule you own none of it until a set date, and with a graded schedule you own more each year. If you leave before you are fully vested, you may lose part of the match. Check your plan document before changing jobs.

Traditional or Roth 401(k)?

Not every plan offers a Roth option. See Roth vs traditional for the logic.

How much can you contribute?

The IRS sets a yearly limit on employee contributions, higher for people aged 50 and over. The amounts change most years, so check the IRS for the current figures. For how much to aim for at each age, see how much you should have in your 401(k) by age.

What are the costs?

You pay the expense ratios of the funds you choose and sometimes a plan administration fee. Choose the lowest-cost funds on the menu. See how expense ratios add up. Your plan's fee disclosure lists the costs.

What happens when you leave your job?

• Leave it in the old plan, if allowed.
• Roll it into your new employer's plan or into an IRA, which keeps the tax benefits.
• Do not cash it out unless you must. You would owe income tax and usually a 10% penalty if you are under 59 and a half, and lose years of growth.

What about borrowing from a 401(k)?

Some plans allow loans, but they carry risks: the money is out of the market, and if you leave your job the balance may become due quickly. Treat a loan as a last resort. Build an emergency fund instead.

Where a 401(k) fits among other accounts is explained in the account order report and how to start investing.

Sources and further reading: the IRS and SEC Investor.gov.

General education, not tax or investment advice. Reviewed October 2026. Plan rules, limits and tax treatment vary, so check your plan documents. Growth figures assume a constant 7% annual return and are illustrations only.

Frequently asked questions