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A 401(k) is one of the best tools for building retirement savings. But many workers enroll without fully understanding how it works. This guide covers everything you need to know — in plain language — for 2026.
What Is a 401(k)?
A 401(k) is a retirement savings account offered by your employer. You contribute a percentage of your paycheck. The money is invested and grows tax-advantaged over time. The name comes from the section of the tax code that created it.
Two main types exist:
- Traditional 401(k): Contributions come out of your paycheck before taxes. You pay taxes when you withdraw in retirement.
- Roth 401(k): Contributions come out after taxes. Withdrawals in retirement are tax-free.
2026 Contribution Limits
You can contribute up to $23,500 in 2026. If you are age 50 or older, you can add a catch-up contribution of $7,500, for a total of $31,000.
If your employer matches contributions, that does not count toward your personal limit. The total limit including employer contributions is $70,000 in 2026 (or 100% of compensation if less).
Contribution limits as of May 2026.
Employer Match: Free Money You Should Never Leave Behind
Many employers match your 401(k) contributions up to a percentage of your salary. A common match is 50% of the first 6% you contribute. If you earn $60,000 and contribute 6% ($3,600/year), your employer adds $1,800/year for free.
Always contribute at least enough to get the full match. Not doing so is like leaving part of your salary on the table.
Vesting Schedules
Employer matching funds may not be fully yours right away. Vesting is the process of earning the right to keep employer contributions when you leave the company.
- Immediate vesting: The match is yours from day one.
- Cliff vesting: You get none of the match until you hit a year requirement (e.g., year 3), then you get 100%.
- Graded vesting: You earn a percentage each year (e.g., 20% per year over 5 years).
Check your plan’s vesting schedule before leaving a job. Staying one more year could be worth thousands.
How 401(k) Investments Work
Your contributions are invested in options your employer provides. These typically include:
- Index funds (tracking the S&P 500, total market, etc.)
- Target-date funds (automatically adjust allocation as you near retirement)
- Bond funds
- Company stock (use with caution — avoid over-concentration)
For most people, a low-cost target-date fund is the simplest choice. Pick the fund closest to your expected retirement year (e.g., Target 2055 Fund if you plan to retire around 2055).
Traditional 401(k) vs Roth 401(k): Which to Choose?
| Feature | Traditional 401(k) | Roth 401(k) |
|---|---|---|
| Tax on contributions | Pre-tax (reduces taxable income now) | After-tax (no deduction now) |
| Tax on withdrawals | Taxed as ordinary income | Tax-free |
| Best for | Higher earners expecting lower taxes in retirement | Younger workers expecting higher taxes in retirement |
| Required Minimum Distributions | Yes, starting at age 73 | No (for original Roth 401k owner) |
If you are young and in a lower tax bracket, the Roth 401(k) is often the better choice. You pay taxes now at a low rate and get tax-free income in retirement. For a deeper comparison, see our guide on Roth vs Traditional IRA.
Early Withdrawal Penalties
Taking money out before age 59.5 triggers a 10% penalty plus income taxes. This can wipe out a large portion of what you saved. Avoid it if at all possible.
Exceptions include separation from service at age 55, disability, substantially equal periodic payments (72(t)), and certain other cases.
What Happens to Your 401(k) When You Leave a Job?
You have four options:
- Leave it with your former employer (if they allow it)
- Roll it over to your new employer’s 401(k)
- Roll it over to an IRA
- Cash it out (not recommended — taxes and penalties apply)
Rolling to an IRA gives you the most investment options and flexibility. See SEP-IRA vs Solo 401(k) if you become self-employed. And track your progress with our retirement savings benchmarks by age.
Frequently Asked Questions
How much should I contribute to my 401(k)?
At minimum, contribute enough to get the full employer match — that is free money. After that, aim for 10-15% of your gross income including the employer match. If you can afford more, consider maxing out at $23,500 in 2026.
Can I contribute to both a 401(k) and a Roth IRA?
Yes. The 401(k) limit and the Roth IRA limit are separate. In 2026 you can contribute up to $23,500 to a 401(k) and up to $7,000 to a Roth IRA, as long as you meet the income requirements for the Roth IRA.
What is a good 401(k) expense ratio to look for?
Look for funds with expense ratios below 0.20%. Index funds from Vanguard, Fidelity, and Schwab often have expense ratios of 0.03% to 0.10%. High fees compound against you over time — a 1% vs 0.05% difference can cost tens of thousands of dollars over a career.
What happens to my 401(k) if my company goes bankrupt?
Your 401(k) is protected. The money in it belongs to you, not your employer. It is held in a trust separate from company assets. A company bankruptcy cannot touch your vested 401(k) balance, though unvested employer match may be lost.
When can I withdraw from my 401(k) penalty-free?
Penalty-free withdrawals begin at age 59.5. Required minimum distributions (RMDs) begin at age 73 for traditional 401(k) plans. Early withdrawals before 59.5 trigger a 10% penalty plus income taxes, with limited exceptions.