How does a 401(k) work?

A 401(k) is a retirement account offered through your employer. Money comes out of your paycheck before income tax, gets invested in funds you choose, and grows untaxed until you withdraw it in retirement, when withdrawals are taxed as income. A Roth 401(k) flips that: taxed now, tax-free later.

The single most important feature is the employer match. If your company matches 50 cents on the dollar up to 6 percent of salary, contributing less than 6 percent means declining free money. Contribute at least to the full match before doing anything else with spare cash.

The IRS caps annual contributions and adjusts the limit most years. For 2026 the employee deferral limit is $24,500, with an additional $8,000 catch-up for those 50 and over and $11,250 for ages 60 through 63. A rule taking effect in 2026 requires those catch-up contributions to be made as Roth contributions if your prior-year Social Security wages exceeded $150,000. Withdrawals before 59 and a half generally cost a 10 percent penalty plus taxes, so treat it as untouchable.