401(k) basics

Part of Financial 101 — free, plain-language reference guides. Not personalised advice. Download the one-page Order of Operations checklist.

In one sentence

A 401(k) is a retirement account your employer sponsors, funded by automatic deductions from your paycheck, with tax advantages that make it the first place most people should put long-term savings — especially when the employer adds money of their own.

How it works

You choose a percentage of each paycheck to contribute. It goes into the account before you ever see it, which is the single most powerful feature: saving happens by default rather than by willpower. Inside the account, you pick investments from a menu your employer’s plan provides — usually a set of mutual funds, often including target-date funds and low-cost index funds.

The tax advantage comes in one of two flavours, and many plans offer both:

Traditional 401(k). Contributions are excluded from your taxable income this year. Money grows untaxed. You pay ordinary income tax when you withdraw in retirement. Good when you expect a lower tax rate later than now.

Roth 401(k). Contributions are made from already-taxed pay. Money grows untaxed. Qualified withdrawals in retirement are tax-free. Good when you expect a higher rate later, or want tax diversification.

Either way, you generally cannot withdraw before age 59½ without a penalty on top of tax, with limited exceptions. Treat the money as unreachable. That is the point.

The employer match

Many employers add money when you contribute — commonly a formula like “50% of what you put in, up to 6% of your salary.” This is compensation you only receive by participating. Not contributing enough to capture the full match is declining part of your pay. It is the closest thing to a guaranteed return that exists, and it is why “get the full match” sits near the top of the order of operations, ahead of even paying down most debt.

One caveat: vesting. Employer contributions may belong to you only after a period of service. Your own contributions are always yours. Check your plan’s vesting schedule before assuming the match is fully in hand.

2026 contribution limits

Who	Employee limit	Notes
Under 50	$24,500	Combined across traditional and Roth 401(k)
Age 50–59, 64+	$32,500	Includes $8,000 catch-up
Age 60–63	$35,750	Higher $11,250 catch-up under SECURE 2.0, if your plan allows
Total incl. employer	$72,000	Cap on employee + employer + after-tax combined

New for 2026: if you earned more than $150,000 in Social Security wages the prior year, your catch-up contributions must be made as Roth. Check box 3 of last year’s W-2.

What to invest in

The Boglehead answer is simple and well-supported: low-cost, broadly diversified index funds, held for decades. Most plans offer a total-market or S&P 500 index fund, an international index fund, and a bond index fund — the three-fund portfolio. If choosing feels overwhelming, a target-date fund matching your expected retirement year does the allocation automatically and is a perfectly good default. What matters most is the expense ratio: look for funds charging a small fraction of a percent per year, and avoid anything charging over one percent.

Common mistakes

Leaving match on the table. The most expensive error, and the most common among people early in their careers.

Cashing out when changing jobs. Small balances get taxed, penalised, and spent. Roll old accounts into your new plan or an IRA instead.

Taking loans against it. Legal in many plans, and a quiet way to interrupt compounding at the worst moment. Treat as a last resort.

Ignoring the fee menu. Two funds with the same holdings can differ enormously in cost. The cheaper one wins over thirty years by a wide margin.

Trading the account. It is a retirement vehicle. Set the allocation, automate, and stop looking.

Checklist

Enrolled · Contributing at least enough for the full match · Know your vesting schedule · Chosen low-cost index or target-date funds · Contribution rate increases automatically each year if the plan offers it · Beneficiary named · Old 401(k)s from previous jobs consolidated.

Related: Roth IRA · Index funds and the three-fund portfolio · The full order of operations