What is a 401(k) and how does it work?

A 401(k) is a retirement account you get through your job. You choose a percentage of each paycheck, your employer sends it into the account before you are paid, and it is invested in funds you pick, with a tax break for saving.

It comes from your paycheck

You set a percentage, like 5%. Each payday that share of your pay goes straight into the account. You never have to move the money yourself.

You pick the investments

Your plan gives you a short menu of funds. You choose one or a few, and your money buys them every payday. If you pick nothing, it goes into the plan's default.

It has a tax break

With a traditional 401(k) you pay less income tax now and pay tax when you take the money out. With a Roth 401(k) you pay tax now and qualified withdrawals later are tax-free.

There is a yearly limit

You can put in up to $24,500 of your pay in 2026. People 50 and over can add $8,000 more. Starting in 2026, if you earned over $150,000 at that job last year, the catch-up must go in as Roth.

Your own money stays yours

Everything you put in, and what it earns, is yours when you leave the job. Money your employer adds may take a few years to become fully yours.

Where the name comes from

401(k) is the section of the US tax code that created this kind of plan. Only employers can offer one, so you get it through your job. Nonprofits and schools often offer a 403(b), and many government employers offer a 457(b), which work in much the same way.

How money gets into the account

When you sign up, you choose how much of each paycheck to put in, usually as a percentage. If you earn $2,000 a paycheck and choose 5%, $100 goes into your 401(k) every payday.

Your employer sends it to the plan before the rest lands in your bank account, and it shows as a line on your pay stub. Because you never hold the money, it is easier to keep saving.

Many employers also add money of their own when you contribute, called a match. How a match works, and how to get all of it, is the next lesson.

What the money is invested in

Money in a 401(k) does not sit as cash. It buys funds, which are baskets that hold many stocks, bonds or both. Your plan offers a menu of maybe 10 to 30 funds, and you choose where your money goes.

A common simple choice is a target-date fund, named for the year you expect to retire. It holds a mix that gets more careful as that year nears. A broad index fund with a low yearly fee is another simple choice.

The value goes up and down with the markets and can fall in some years. Over decades, investing gives your money a chance to grow faster than prices rise.

The tax break

Most plans offer a traditional 401(k), and many also offer a Roth 401(k). The difference is when you pay income tax.

With traditional, your contribution comes out before income tax is figured, so you pay less tax this year. You pay income tax later, when you take the money out in retirement. With Roth, you pay income tax now, and qualified withdrawals in retirement are tax-free, growth included.

Social Security and Medicare taxes still apply either way. Choosing between the two has its own lesson, and any contribution beats waiting while you decide.

Getting money out

A 401(k) is meant for retirement. If you take money out before age 59½, you usually pay income tax on it plus a 10% additional tax, with some exceptions.

Some plans allow loans or hardship withdrawals, but both have costs. Treat the account as money you won't touch, and keep an emergency fund for surprises.

When you leave the job

The money you put in, and anything it has earned, is always 100% yours. Employer money may follow a vesting schedule, which means it becomes yours over a few years of work.

When you leave, you can usually leave the account where it is, or move it to your new employer's plan or an IRA. Cashing out usually means income tax plus the 10% additional tax if you are under 59½.