What Is a 401(k) Plan and How Does It Work?

A 401(k) is an employer-sponsored retirement plan that comes with tax benefits. Basically, you put money into a 401(k) where it can be invested and potentially grow tax-free over time. In most cases, you choose how much money you want to contribute to your 401(k) plan based on a percentage of your income. Your employer will then automatically withhold a portion of each paycheck and put it into the account, making it easy to regularly contribute to your account. 

With a traditional tax-deferred 401(k), the money is taken out of your paycheck before federal income taxes are figured, providing you the chance to reduce your taxes today. You pay ordinary income taxes on the pre-tax contributions and growth when you make a withdrawal in retirement.  

Most employers offer a Roth 401(k) as well. Contributions to Roth accounts are made with after-tax dollars, which means you don't get a tax deduction. Instead, your money can potentially grow tax free and be withdrawn in retirement without any taxes.  

Here's a side-by-side look at how traditional and Roth 401(k) accounts differ. 

Many employers contribute to your 401(k) on top of what you put in, but how much of that money is actually yours can depend on how long you stay with the company. Here's how matching and vesting work together.

If your employer offers a 401(k) match, it means they'll put money into your retirement account based on the amount you put in. How the matching works will depend on the specifics of your employer's plan. For example, an employer could offer a dollar-for-dollar match, up to a certain dollar limit. Or an employer match can be based on a percentage of the contributions you make and a percentage of your wages.  

A typical 401(k) match formula is 50% of your contributions, up to 6% of your pay. Under that formula, if you earn $6,000 per month and contribute $360 (6% of your wages), your employer will add $180, for a combined contribution of $540 per month. To capture the full match, you'd need to contribute at least 6% of your pay.

Vesting is a term that describes how much of the money in your account is actually yours, if you were to leave the company. 

Employee contributions are immediately vested and always considered yours. Employer matching and employer contributions may be subject to a vesting schedule, which means you may need to stay with the company for a certain period of time before those contributions fully belong to you. Some employers, however, provide immediate vesting of matching contributions. Check with your plan administrator for the vesting requirements in your particular 401(k) plan. 

How much you contribute to your 401(k) can have a major impact on your retirement savings over time. Before deciding how much to save, it can help to understand the annual contribution limits, guidelines for how much to set aside, and whether to consider maxing out your 401(k).

There are a few 401(k) contribution limits to keep in mind:

How much you should contribute to your 401(k) depends on your retirement goals and how much you hope to accumulate in your nest egg by the time you retire. While you don't have to contribute the maximum allowed by the IRS, it's worth noting that the more you invest now, the greater the head start you'll likely have toward a comfortable retirement.  

The longer you wait to save, the more you'll need to save annually for retirement. Every situation will vary, but here are age-based guidelines on how much you should save based on when you start saving for retirement: 

• If you start in your 20s, save 10% to 15% of your salary, including employee match, per year for retirement.
• If you start in your 30s, save 15% to 20% of your salary, including employee match, per year for retirement.
• If you start in your early 40s, save 25% to 35% of your salary, including employee match, per year for retirement.
• If you start later, save as much as possible, and consider other strategies, such as retiring later. 

If you have more questions, be sure to ask a tax professional or financial advisor for more information about savings strategies for your 401(k). 

Maxing out means contributing up to the annual IRS limit. In 2026, that means: 

• $24,500 if you're under 50
• $32,500 if you're 50 or older ($24,500 + $8,000 catch-up contribution)
• $35,750 if you're age 60 to 63 ($24,500 + $11,250 super catch-up contribution) 

For most workers, maxing out isn't realistic every year, and it doesn't need to be. A more practical approach is to start with the employer match, then increase your contribution rate by one or two percentage points each year—ideally timed with a raise so the increase doesn't reduce your take-home pay. Bonuses and tax refunds are also natural moments to bump up your contribution. 

If you do have room to max out, the earlier in the year you front-load contributions, the more time your money has to grow. But watch your match: some plans match per paycheck rather than annually, so front-loading can mean missing match dollars later in the year. Check your plan's matching rules before changing your pace. 

A 401(k) election isn't something to set and forget. The IRS raises the contribution limit most years, so a flat-dollar election that maxed you out last year may leave room on the table this year. A raise can also change what a percentage-based contribution actually puts in the account, and catch-up eligibility kicks in at age 50 and again at 60. Open enrollment is a natural moment to revisit your election.

Generally, if you take money from your 401(k) account before you reach age 59½, you'll have to pay taxes on the pre-tax contributions and any growth, plus pay a 10% penalty. But there are some exceptions to the early withdrawal penalty.

One exception is known as the rule of 55. Under this rule, if you lose or leave your job at age 55 or older and take distributions from the 401(k) associated with your most recent job, you won't have to pay the 10% penalty. Other circumstances that might allow you to avoid the 10% penalty include: 

• Certain qualified birth or adoption expenses
• A series of substantially equal payments (known as the 72(t) exemption)
• Permanent disability 

You may need to provide documentation to avoid penalty in these cases, so make sure you're prepared to do so. To learn more about the exemptions to the 10% penalty, see the IRS website.

Some plans allow hardship withdrawals for an immediate and heavy financial need. Hardship withdrawals are generally taxable and may still be subject to the 10% penalty, unless another exception applies. 

Some plans may also allow loans, which let you borrow from your account and repay the money over time. Unlike a withdrawal, a 401(k) loan generally isn't taxable if it follows plan rules and is repaid on time. However, not all plans allow loans, and unpaid loan amounts may be treated as taxable distributions. 

Before taking a 401(k) withdrawal or loan, review your plan rules and consider the potential tax consequences and impact on your retirement savings.

Once you reach retirement age, your 401(k) shifts from a savings account to an income source—and you have decisions to make about how to access the money.

Most plans give you several ways to take distributions once you've separated from your employer at or after 59½. Common options include taking periodic distributions on a schedule, taking lump-sum distributions as needed, or, in some plans, converting your balance to an annuity that pays a set amount over time. You can also leave the money in your former employer's plan if permitted, or roll your 401(k) into an IRA for more investment flexibility and simpler distribution management. The right choice depends on your income needs, the investment choices in your current plan, and how you want to coordinate with other retirement income sources. 

In general, once you reach age 73 (or 75, if you were born in 1960 or later), you must begin taking required minimum distributions (RMDs) from all tax-deferred retirement accounts, including 401(k)s. Generally speaking, you can calculate your RMDs for a given year by taking your 401(k) account balance on December 31st of the prior year and dividing it by your "distribution period"—a number the IRS assigns to each age. 

For example, let's say you're 75, single, and ended last year with $1 million in your 401(k). According to the IRS, your distribution period is 24.6—which means your RMD for the year would be $40,650 ($1,000,000 ÷ 24.6). 

If you have multiple tax-deferred retirement accounts, RMDs must be calculated separately for each one. Many financial institutions, including Schwab, will help calculate your RMDs for you—and may even offer automated withdrawals—but typically only for the accounts held at their firms.

Most retirees draw income from more than one source: a 401(k) or IRA, taxable brokerage accounts, Roth accounts, and Social Security. The order in which you tap each can affect your lifetime tax bill, since traditional 401(k) withdrawals count as ordinary income while Roth withdrawals generally don't. A common retirement withdrawal strategy is to draw from taxable accounts first, then tax-deferred accounts, then Roth—but the right sequence depends on your tax bracket, your RMD obligations, and your other income. Consider working with a tax professional or financial advisor to map out a withdrawal strategy that fits your situation.