How it works
A 401(k) is a retirement plan run by your employer. You choose a percentage of each paycheck to contribute, the plan invests it in funds you select, and the money grows until you take it out in retirement.
Because contributions come straight out of your pay, saving becomes automatic, and automatic saving is one of the most reliable habits in investing.
Traditional and Roth 401(k)
Many plans offer two tax flavors. With traditional contributions you skip income tax now and pay it on withdrawal. With Roth contributions you pay tax now and qualified withdrawals are tax-free. It is the same trade described in Roth vs traditional.
The employer match
Some employers add money when you contribute, for example 50 cents for every dollar you put in up to 6% of your pay. That is part of your compensation. On a 60,000 dollar salary, contributing 6% (3,600 dollars) would bring a 1,800 dollar match under that example. Check your plan’s exact formula.
Vesting
You always keep your own contributions. Employer money may be subject to a vesting schedule, meaning you earn the right to keep it over a number of years of service. Leave early and you may forfeit part of it.
Choosing investments
The plan offers a menu, often a mix of index funds, actively managed funds and target-date funds. A target-date fund adjusts its stock and bond mix as the target year approaches, which makes it a common default. Compare each option’s expense ratio, since fees compound against you.
Limits and access
- The IRS sets a yearly contribution limit that is higher than the IRA limit, with extra room for older savers. Look up the current figure at irs.gov.
- Withdrawals before about age 59½ generally bring tax and a penalty, with exceptions. Some plans allow loans.
- When you change jobs you can often roll the balance into an IRA or your new employer’s plan to avoid taxes and penalties.
Quick answers
Is a 401(k) safe if my employer fails?
Your 401(k) money is held separately from the company’s assets, in a trust, so it is generally protected. Your investments can still lose value like any others.