A 401(k) is an employer-sponsored retirement savings plan that lets you invest pre-tax income — reducing your taxable income today while your investments grow tax-deferred until retirement. For most Americans, it's the single most powerful tool for building long-term wealth.
How Contributions Work
You elect to have a percentage of each paycheck contributed to your 401(k) before income taxes are deducted. The 2024 contribution limit is $23,000 per year ($30,500 if you're 50 or older via catch-up contributions). Contributing $1,000/month reduces your taxable income by $1,000/month — saving you money on taxes now.
The Tax Advantage
In a traditional 401(k), contributions are pre-tax. You don't pay income tax on contributions until you withdraw in retirement. If you're in the 22% tax bracket, every $1,000 contributed saves $220 in taxes today. In retirement, you'll likely be in a lower bracket, making withdrawals cheaper than contributions would have been at your working-life rate.
Roth 401(k)
Many employers also offer a Roth 401(k) option. Contributions are made after-tax (no upfront tax break), but all growth and qualified withdrawals in retirement are completely tax-free. Roth is generally better if you expect your tax rate in retirement to be higher than today.
Employer Matching — Free Money
- Many employers match 50%–100% of your contributions up to a percentage of your salary
- Example: 'We match 100% of the first 4% of your salary' — contribute at least 4% to get full match
- This is an immediate 50–100% return on your contribution — always contribute enough to get the full match
- Unvested matching contributions may be forfeited if you leave before the vesting schedule completes
Withdrawal Rules
You can begin penalty-free withdrawals at age 59½. Early withdrawals incur a 10% penalty plus income tax. Required Minimum Distributions (RMDs) must begin at age 73. If you leave your job, you can roll the 401(k) into a new employer's plan or into an IRA, preserving the tax-deferred status.
If your employer offers a 401(k) match and you're not contributing enough to receive the full match, you're leaving tax-free money on the table. This is always the first priority in any financial plan.