What is a 401(k)?

A 401(k) is one of the most popular retirement savings accounts in the United States. Named after a section of the Internal Revenue Code, it allows employees to contribute a portion of their pre-tax income to a retirement investment account. These contributions grow tax-deferred, meaning you don’t pay taxes on them until you withdraw the money in retirement.

Employers often offer 401(k) plans as part of a benefits package. Some even match a portion of the employee’s contributions, which is essentially free money for retirement. But not all plans are created equal, and not everyone has access to one. Whether you’re just learning about personal finance or already investing regularly, understanding how a 401(k) works is key to building long-term wealth.

Benefits of a 401(k)

Tax Advantages
Traditional 401(k) contributions reduce your taxable income for the year, which may lower your tax bill. For example, if you earn $60,000 and contribute $6,000, you’re only taxed on $54,000. There are also Roth 401(k) options, where you contribute after-tax dollars but enjoy tax-free withdrawals in retirement.

Employer Matching
Many companies match a percentage of your contributions, often up to a certain percent of your salary. A common formula is a 100% match of the first 3% of your salary and 50% of the next 2%. If you’re not contributing enough to get the full match, you’re leaving money on the table.

High Contribution Limits
For 2025, the IRS allows employees to contribute up to $23,000 to a 401(k), with an additional $7,500 catch-up contribution allowed if you’re age 50 or older. This is significantly more than what’s allowed in an IRA.

Automatic Payroll Deductions
Contributions are deducted directly from your paycheck, making saving easy and consistent. Over time, these contributions compound and grow through investments in things like index funds, including S&P 500 funds.

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What to Consider Before Contributing

Fees
Not all 401(k) plans are cost-effective. Some have high administrative or fund management fees that can eat into your returns. Before contributing, review your plan’s fee structure.

Investment Options
A good 401(k) offers a range of low-cost index funds. If your plan is filled with expensive or poor-performing funds, it might not be the best vehicle for your retirement savings.

Vesting Schedule
Some employers require you to stay with the company for a certain number of years before their matching contributions are fully yours. This is called a vesting schedule. If you’re thinking about switching jobs, understand how much of your employer’s contributions you can keep.

Financial Priorities
Make sure you have an emergency fund—preferably in a high-yield savings account—and aren’t carrying high-interest debt. A 401(k) is a long-term investment. You typically can’t access the money without penalty until age 59½.

What If Your Employer Doesn’t Offer a 401(k)?

Not every American has access to an employer-sponsored retirement plan. If that’s your situation, consider these alternatives:

Roth IRA or Traditional IRA
You can open an Individual Retirement Account on your own through a brokerage. While the annual contribution limit is lower than a 401(k), these accounts still offer tax advantages and access to low-cost investments.

Taxable Brokerage Account
If you’ve maxed out your IRA, consider investing in a regular brokerage account. There are no tax breaks, but you have complete flexibility and access to a wide range of investments.

Short-Term Treasuries and High-Yield Savings Accounts
If you’re saving for shorter-term goals or want to protect your cash, look into Treasury bills or an FDIC-insured high-yield savings account. These are good places to park money while you prepare to invest for the long haul.

What If Your Employer Offers a 401(k) With No Match?

Even without a match, a 401(k) can still be a useful tool, especially for high earners who want to lower their taxable income. But if you’re choosing between this and other savings options, consider your priorities.

First, check the quality of the plan. If the investment options are solid and fees are low, it may be worth using for its tax advantages. But if the plan is expensive or limited, you might want to contribute just enough to stay in the habit of saving, while putting most of your money into a Roth IRA or brokerage account.

Final Thoughts

A 401(k) can be a powerful part of your retirement strategy, but it’s not the only path to building wealth. Understanding your options, paying attention to fees, and aligning your contributions with your financial priorities is what really moves the needle.

Whether you’re using a 401(k), a Roth IRA, or simply tracking your spending with a budgeting app, the key is consistent, intentional saving. The more you learn about money—through books, habits, and experience—the better your financial decisions will be.