What is 401(k)?

A 401(k) plan is an employer-sponsored, tax-advantaged retirement savings account defined under Section 401(k) of the Internal Revenue Code. Primarily regulated by the Employee Retirement Income Security Act (ERISA) of 1974, it allows eligible employees to save for retirement by directing a portion of their pre-tax or post-tax salary into the account. In a traditional 401(k), employee contributions are made with pre-tax dollars, which directly reduces the employee's adjusted gross income (AGI) for the current tax year. The funds inside the account grow tax-deferred, meaning no capital gains or dividend taxes are assessed annually, and distributions are taxed as ordinary income upon withdrawal in retirement.

A major benefit of a 401(k) plan is the employer matching contribution, where companies incentivize savings by matching employee contributions up to a certain percentage of their salary (e.g., matching 100% of the first 4% contributed). For the 2026 tax year, the IRS limits individual elective deferrals to $24,500 ($23,500 in 2025). To help older workers catch up, the IRS allows additional catch-up contributions of $8,000 in 2026 ($7,500 in 2025) for those aged 50 and older, bringing their total elective limit to $32,500. Under the SECURE 2.0 Act, a special higher catch-up limit of $11,250 applies to participants aged 60 to 63 in 2026, permitting a total elective contribution of $35,750. Additionally, under SECURE 2.0 rules, catch-up contributions made by employees whose prior-year compensation exceeded $145,000 must be made on a Roth (after-tax) basis.

Unlike standard savings accounts, 401(k) plans are strictly long-term investment vehicles. Withdrawals made before reaching age 59½ are generally subject to a 10% early withdrawal penalty in addition to standard ordinary income tax, unless they qualify for specific exceptions (such as disability, birth or adoption of a child, or the 'Rule of 55' for employees departing their jobs). Plans are also subject to strict IRS non-discrimination testing to ensure that the plan does not unfairly benefit highly compensated employees over rank-and-file workers.