A 401(k) is one of the most valuable retirement savings tools available to American workers. Named after the section of the tax code that created it, a 401(k) allows you to save for retirement with significant tax advantages.
How it works: Money is deducted from your paycheck before income taxes are calculated (for traditional 401k), lowering your taxable income today. The money grows tax-deferred until you withdraw it in retirement, when it's taxed as ordinary income.
Employer Match: Many employers offer matching contributions—essentially free money. A common match is 50% of your contributions up to 6% of your salary. If you earn $60,000 and contribute 6% ($3,600), your employer adds $1,800. Not contributing enough to get the full match is leaving money on the table.
2024 Contribution Limits: - Under 50: $23,000 per year - 50 and older: $30,500 (includes $7,500 catch-up contribution)
Traditional vs Roth 401(k): - Traditional: Pre-tax contributions, taxed at withdrawal - Roth: After-tax contributions, tax-free withdrawals in retirement - Many experts recommend Roth for younger workers in lower tax brackets
Important Rules: - Early withdrawals (before 59½) typically incur a 10% penalty plus taxes - Required Minimum Distributions (RMDs) start at age 73 - Loans from your 401(k) are possible but generally not recommended
The Power of 401(k) Investing
Starting at age 25, contributing $500/month with 7% average returns:
- By age 35: ~$86,000 saved
- By age 45: ~$262,000 saved
- By age 55: ~$590,000 saved
- By age 65: ~$1,200,000 saved—millionaire status from $500/month!
Key Takeaways
- Always contribute enough to get the full employer match
- Contribution reduces your current taxable income
- Choose between traditional (pre-tax) and Roth (after-tax) based on your situation
- Investments grow tax-deferred for decades
- Early withdrawal penalties discourage using it as a piggy bank
- When you leave a job, you can roll over to an IRA or new employer's plan