Sep 20 · 2 min read
Key Takeaway: A 401(k) is a retirement plan provided to you by your employer. It allows you to grow your retirement savings by investing money in assets like stocks and bonds. Your employer may even help you out by adding money of their own into your account.
A 401(k) is a retirement savings account that is provided to you by your employer. As an employee, a 401(k) allows you to save for retirement by automatically investing money from your paycheck into your choice of funds. These funds include investments like stocks, bonds, or even your company’s stock.
No matter what funds you choose to put your money in, employers often match a certain percentage of your contributions to your 401(k). As an example, if you choose to automatically put 6% of every paycheck into your 401(k), an employer might add an additional 3% or even the full 6% to your account if you’re lucky. This is called an “employer match” and is essentially free money! This free money is arguably the main benefit of using a 401(k).
Another benefit of using a 401(k) is its tax advantages. Depending on what type of 401(k) you choose ( Traditional or Roth ), you will be allowed to either defer taxes when you put money into your 401(k) or when you withdraw money from your 401(k). With a Traditional 401(k), you add money to your account before paying taxes on it. While this may sound like an immediate “no brainer”, there is a catch. With a Traditional 401(k), you will have to pay taxes on your money when you withdraw it from your 401(k). A Roth 401(k) on the other hand lets you add money to your account after paying taxes on it. In return, you will not have to pay taxes when you withdraw money from your 401(k) later in life.
To help you decide which type of 401(k) is best for you, we go deeper into the differences of Traditional and Roth 401(k)s here .
While a 401(k) can help you save for retirement, it will also come with plenty of rules. You’ll be limited on how much you can contribute to it each year based on your age and income. Learn more about 401(k) contribution limits here . You also won’t be able to withdraw from it penalty-free until you turn 59 ½ (or 55, if you are fired or retire from your job between ages 55 & 59 ½). Learn more about 401(k) early withdrawal penalties here .
In most cases, you also won’t be able to touch your employer’s contributions immediately. This is because employer’s matching deposits into your 401(k) are on a vesting schedule. In a nutshell, this means any money your job puts into your 401(k) won’t truly be yours until after a set period of time. This is called vesting and employers use it as insurance against employees leaving early and taking the company’s match with them.
So you may be wondering, “What if I leave my current job?” Don’t worry, if you happen to change jobs, you can take your 401(k) with you without penalty. This is because you will have the option to either transfer your 401(k) into your new job’s 401(k) or convert it into an IRA (Individual Retirement Account) . We also made an entire guide walking you through the details of what you should do with your 401(k) when you get a new job so check it out if this applies to you! Learn more about what to do with your 401(k) when switching jobs .