What is a 401k? A Comprehensive Guide to Retirement Savings

A 401(k) is a retirement account that is commonly offered by employers to their employees as a way to put money away for their post-working days. This account is a pre-tax account, where money goes in before you’re taxed on it, and it grows tax-free. When you get to retirement, you’re able to pull the money out, and then you will pay taxes on it.

This account is a common way for people to passively put money away for retirement. In the past, employers offered pensions, but that has largely gone away. 

If you’re offered a 401(k) by your employer, it’s likely beneficial for you to put a part of your paycheck away each pay cycle. A swath of Americans unfortunately have no retirement savings, or not enough. But contributing to your employer-sponsored retirement plan can be a great first step towards having a comfortable retirement.

WorkMoney put together a comprehensive guide about 401(k) plans, including how you can use this account to prepare yourself for a comfortable retirement.

What Is A 401(k) And How Does It Work?

A 401(k) is an employer-sponsored plan, meaning that you have to work for someone who offers it as part of their benefits package. The vast majority of private employers offer this as part of their benefits package, but 4 in 10 workers aren’t contributing. 

The plan works like this: you set how much you want taken out of your paycheck, typically by percentage. This is deducted from your pre-tax income, which means you have less taxable income at the end of the year. Keep in mind that there is an option to opt for a Roth 401(k), which takes funds from your paycheck post-tax. Choosing between the two typically depends on your long term tax strategy and projected income. 

The money in the account can be invested in a number of different investments, which are determined by who offers the 401(k) plan. It’s not as robust as a typical brokerage accounts, where you can invest in a wide variety of equities and other assets. Each plan will vary in what you can invest in, but it’s typically between target-date funds and target allocation funds. 

Keep in mind that there are limits to how much you can contribute to a 401(k), and those limits typically change each year. Here are the limits for 2025 and 2026:

Why a 401(k) Matters

A 401(k) is a foundational account for growing your net worth as many employers offer a match to incentivize employees to save for retirement. This typically comes in the form of a percentage match. Here’s an example:

Let’s say you make $70,000 a year and your employer offers a 100% match on the first 5% you contribute to your 401(k).

If you put in 5% of your salary ($3,500), your employer adds another $3,500 — free money. That’s an instant 100% return before your investments even grow.

Over 20 years, assuming a 7% annual return and compound interest, your combined contributions could grow to about $285,000. Without the match, you’d have around $142,000.

That’s more than $140,000 of extra savings — all thanks to taking full advantage of your employer’s match.

This account not only helps your future self, the money you divert reduces your annual taxable income. Here’s how that works, using the example above:

Your $3,500 contribution is pre-tax, meaning it’s taken out of your paycheck before taxes are calculated. Instead of paying income tax on your full $70,000, you’re only taxed on $66,500.

If you’re in the 22% federal tax bracket, that saves you about $770 in taxes this year — just for contributing to your 401(k).

So in one move, you:

• Get a 100% employer match (an instant return)

• Lower your taxable income

• Let your money grow tax-deferred until retirement

How to Start Contributing to a 401(k)

If you’re unsure if your employer offers a 401(k) account, be sure to contact your HR department. They will be able to inform you if you have one or not, and how to set up automatic contributions.

If they do offer one, be sure to ask if there is an employer match available. If there is a match, do your absolute best to contribute enough to get the match. If you can contribute more, even better, but be sure to keep your monthly budget in mind as well. The general rule of thumb from financial experts is to save 15% of your gross salary. So at $70,000 per year, you should aim to put away $10,500 per year.

Here’s the best part: once you take 15 minutes to set up your 401(k), you generally don’t need to touch it again. It’s advised to review your plan annually to make sure plan details haven’t changed, and ensure your contact information is up to date.

Pro tip: your 401(k) plan likely has a section to designate a beneficiary, in case something happens to you. This is typically a spouse or child. Be sure to have that completed.

Frequently Asked Questions About 401(k) Accounts

What happens to my 401(k) if I change jobs?

The money is still yours. You can roll it over into your new employer’s 401(k) or a traditional IRA to keep your money growing tax-deferred.

When can I withdraw money from my 401(k)?

You can start penalty-free withdrawals at age 59½. Taking money out earlier generally triggers taxes and a 10% penalty.

Can I lose money in my 401(k)?

Yes — your balance can fluctuate with the market. But since 401(k)s are long-term investments, short-term dips often recover over time.

What is a 401(k) loan?

A 401(k) loan lets you borrow money from your own retirement savings and pay it back with interest over time, usually through automatic payroll deductions. While it can provide quick access to cash, taking a loan reduces the amount invested for retirement and may have taxes or penalties if not repaid on schedule.

Are all 401(k) plans the same?

No — plans vary by employer in terms of eligibility, matching, investment options, fees, vesting schedules, etc. It’s important to review your specific plan’s rules.

Final Thoughts

A 401(k) is an excellent way to passively save for retirement. However, you aren’t only limited to that account. You can also open an IRA on your own outside of an employer-sponsored retirement plan.

Retirement isn’t an age you hit, but rather an amount of money you can save to sustain the lifestyle you want.