What is a 401(k)?
A 401(k) is a tax-advantaged retirement savings account offered by employers in the United States. The name comes from the section of the Internal Revenue Code that authorizes it: Section 401(k). Employees can elect to defer a portion of their pre-tax (or after-tax, in the case of a Roth 401(k)) salary directly into the account, where it can be invested in a menu of mutual funds, index funds, target-date funds, or other options provided by the plan.
The defining feature of a traditional 401(k) is the tax deferral: contributions are made before income taxes are applied, reducing your taxable income today. The account then grows tax-deferred — meaning you pay no annual taxes on dividends, interest, or capital gains while the money remains in the plan. Taxes are owed only upon withdrawal, typically in retirement when many individuals are in a lower tax bracket.
Withdrawals before age 59½ generally trigger a 10% early withdrawal penalty on top of ordinary income taxes, with limited exceptions for circumstances such as permanent disability, certain medical expenses, or a qualified domestic relations order (QDRO). Required Minimum Distributions (RMDs) must begin at age 73 under current law, requiring account holders to withdraw a minimum amount each year based on IRS life-expectancy tables.
Traditional vs Roth 401(k)
Many employers now offer both a traditional (pre-tax) and a Roth (after-tax) option within the same 401(k) plan. The core difference is when you pay taxes:
| Feature | Traditional 401(k) | Roth 401(k) |
|---|---|---|
| Contributions | Pre-tax (reduces current taxable income) | After-tax (no current deduction) |
| Growth | Tax-deferred | Tax-free (if qualified) |
| Qualified withdrawals | Taxed as ordinary income | Tax-free |
| RMDs | Required starting at age 73 | No RMDs (as of SECURE 2.0, effective 2024) |
| Best if… | You expect a lower tax rate in retirement | You expect a higher tax rate in retirement |
If you are early in your career and currently in a lower tax bracket, a Roth 401(k) can be particularly valuable because you lock in today's lower rate and all future growth is never taxed. Conversely, high-income earners who expect their tax rate to decline in retirement may benefit more from the immediate deduction of a traditional contribution. Many planners suggest splitting contributions between both types to achieve tax diversification — a hedge against future uncertainty in tax law.
The Power of Employer Matching
Employer matching is one of the most valuable components of a 401(k) plan. When your employer matches a portion of your contributions, they are effectively adding to your compensation — at no cost to you beyond the contribution you were already making. A common structure is a 50% match on the first 6% of your salary: if you earn $75,000 and contribute 6%, your employer adds another 3% ($2,250) to your account each year.
Failing to contribute enough to capture the full employer match means leaving a portion of your total compensation on the table. Over a 30-year career, even a small annual employer match can compound into a six-figure sum, particularly when combined with investment growth on those matched dollars.
Note that employer contributions may be subject to a vesting schedule — meaning you must remain employed for a certain period before the employer's contributions are fully yours. Common vesting schedules include cliff vesting (100% vested after 3 years) and graded vesting (gradually increasing from 20% to 100% over 6 years). Check your plan documents to understand your specific vesting terms.
401(k) Contribution Limits (2025)
The IRS adjusts 401(k) contribution limits periodically to account for inflation. For tax year 2025, the key limits are:
- Employee elective deferral limit: $23,500 (up from $23,000 in 2024)
- Catch-up contribution (age 50–59 and 64+): Additional $7,500, for a total of $31,000
- Enhanced catch-up contribution (age 60–63): Additional $11,250 under SECURE 2.0, for a total of $34,750
- Total annual additions limit (employee + employer): $70,000 or 100% of compensation, whichever is less
These limits apply to the combined traditional and Roth elective deferrals across all 401(k) plans you participate in during the year. Employer contributions are tracked separately and do not reduce your employee deferral limit. This calculator does not automatically enforce the IRS deferral cap — if your projected contributions exceed the limit, you would need to reduce your contribution rate accordingly. Always verify current-year limits at IRS.gov or with your plan administrator.
Frequently Asked Questions
How much should I contribute to my 401(k)?
A widely cited starting point is to contribute at least enough to capture your full employer match — often called "free money" because it is a direct addition to your compensation. Beyond that, many financial educators suggest aiming for 10–15% of gross income (including the employer match) as a long-term savings rate, though your ideal figure depends on your current age, existing savings, expected retirement expenses, and other income sources such as Social Security. This calculator lets you experiment with different contribution rates to see how each choice projects over time.
What is the 401(k) contribution limit for 2025?
For 2025, the IRS allows employees to defer up to $23,500 of their own salary into a 401(k) or 403(b) plan (up from $23,000 in 2024). Workers aged 50 and older may make an additional catch-up contribution of $7,500, bringing their total to $31,000. A new provision introduced by SECURE 2.0 allows workers aged 60–63 to make a higher catch-up contribution of $11,250 instead, for a total of $34,750. These limits apply to traditional pre-tax and Roth 401(k) contributions combined. Employer contributions are separate and do not count toward the employee deferral limit.
What is the difference between a traditional 401(k) and a Roth 401(k)?
A traditional 401(k) accepts pre-tax contributions, meaning contributions reduce your taxable income in the year they are made. Withdrawals in retirement are taxed as ordinary income. A Roth 401(k) accepts after-tax contributions — you pay income tax now, but qualified distributions in retirement are tax-free, including all investment growth. The better choice depends on whether you expect your tax rate to be higher now or in retirement. Many plans allow you to split contributions between both types. This calculator models the accumulation phase only and does not factor in the tax treatment of either account type.
What is the 4% rule used for retirement income estimates?
The 4% rule is a widely discussed guideline derived from research by financial planner William Bengen in 1994, later expanded by the Trinity Study. It suggests that a retiree can withdraw 4% of their portfolio in the first year of retirement, then adjust that dollar amount for inflation annually, with a historically observed high probability of the portfolio lasting 30 years across various market conditions. This calculator applies it simply: projected balance × 4% ÷ 12 = estimated monthly income. The rule has limitations — it assumes a specific asset allocation, does not account for taxes or fees, and historical conditions may not repeat. It is a rough planning benchmark, not a withdrawal strategy.