401(k) Plan

A 401(k) plan is a retirement savings plan offered by US employers that lets workers put part of each paycheck into investments with tax advantages. The name comes from section 401(k) of the Internal Revenue Code. Employees choose how much to contribute, the money is usually invested in mutual funds or similar products, and many employers add a matching contribution.

The 401(k) is the most common form of defined contribution plan in the United States, where the final pot depends on contributions and investment returns rather than a promised income. It largely replaced the traditional defined benefit pension in the private sector. The Internal Revenue Service sets the tax rules and the Department of Labor oversees how plans are run.

Think of a 401(k) as a savings jar at work with a special lid. Each payday a slice of your pay drops into the jar before you ever see it, and the jar is invested so it can grow. In many jobs your employer adds a few coins of its own every time you add yours, which is the closest thing to free money in personal finance.

The catch is the lid. The tax office gives you a break for using the jar, but in return you are expected to leave the money alone until retirement age. Open it early and you usually pay tax plus an extra charge. Leave it, and years of small additions and growth can build into a large sum.

Section 401(k) was added to the tax code by the Revenue Act of 1978. It was meant to clarify the treatment of deferred pay, but benefits consultant Ted Benna argued in 1980 that it allowed salary-deferral savings plans, and IRS rules issued in 1981 confirmed the approach. Large employers adopted the plans quickly through the 1980s. Roth 401(k) accounts became available in 2006, and the SECURE 2.0 Act of 2022 required most new plans to enrol workers automatically, among other changes.

Contributions come in two main forms:

• Traditional (pre-tax) contributions. Money goes in before income tax, lowering taxable pay today; withdrawals in retirement are taxed as income.
• Roth contributions. Money goes in after tax, and qualified withdrawals, including growth, are tax-free.
• Employer contributions. Matches or profit-sharing amounts, often subject to a vesting schedule such as cliff vesting, under which the worker owns the money only after a set period.

Several related plans follow similar rules. The 403(b) serves employees of public schools and many nonprofit organizations, the 457(b) covers state and local government workers, and the solo 401(k) lets a self-employed person with no staff act as both employer and employee. Safe harbor 401(k) designs commit the employer to a set level of contributions in exchange for lighter annual testing of whether the plan favours highly paid staff.

The IRS caps how much an employee can defer each year and adjusts the limit for inflation; for 2026 the employee limit is $24,500, with higher catch-up amounts for people aged 50 and over. Investments grow without annual tax, which lets compounding work on the full balance. Most plans offer a menu of funds, often including target-date funds that shift asset allocation towards bonds as retirement approaches.

Withdrawals before age 59½ generally trigger income tax plus a 10% additional tax, with exceptions for hardship, disability and some other cases. Many plans let members borrow from their balance and repay through payroll. When someone changes jobs they can leave the money, move it to the new employer's plan, or roll it into an individual retirement account without tax if the transfer is done correctly. Required minimum distributions begin in the early seventies for traditional balances, while Roth 401(k) balances are no longer subject to them during the owner's lifetime.

Critics note that the 401(k) shifts investment and longevity risk from employers to workers, who may save too little, pay high fees or sell in a bear market. Fees matter: a fund's expense ratio compounds against the saver over decades. Access is uneven, since many small employers do not offer a plan, and the tax benefit is worth more to higher earners. Crypto exposure is another debate; in 2022 the Department of Labor warned plan fiduciaries to use extreme care before adding cryptocurrency options, guidance it rescinded in 2025.

• Internal Revenue Service: 401(k) plans
• US Department of Labor: Employee Benefits Security Administration