A 401(k) is a retirement savings plan that is sponsored by your employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.

401(k) plans are named for the section of the tax code that governs them.  They became popular in the 1980s as a way to supplement to pensions, when they still offered pension funds. Pension funds were managed by the employer and they paid out a steady income over the course of your retirement.  As the cost of running pensions escalated, employers started replacing them with 401(k)s.

A 401(k) let's you control how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be target-date funds, a combination of stocks and bonds that gradually become more conservative as you reach retirement.

While a 401(k)can help you save, they have plenty of restrictions. In most cases, you can’t tap into your employer’s contributions immediately. You have to "Vest" first.  Vesting is the amount of time you must work for your company before gaining access to its payments to your 401(k). (Your payments begin vesting immediately.) This is insurance against employees leaving early. There are also complex rules about when you can withdraw your money and costly penalties for pulling funds out before retirement age.

Your employer usually hires an investment firm to oversee your account. They’ll email you updates about your plan and its performance, manage the paperwork and assist you with requests. If you want to keep watch over your account or shift your money around, go to your administrator’s web site or call their help center.

So, how much should you put in? As much as possible but remember that you’ll need to have enough money to live, eat and pay down any debt you have. At the very least, invest enough to get the full matching amount that your company pays to match your contributions. You don’t want to leave free cash on the table. Nearly every plan offers matching funds, usually starting at 3% of your salary.

So how does that 3% match work? When you put in 3% of your $50,000 salary, or $1,500, your company puts another $1,500 in the pot. You can add more than that $1,500 yourself, but the company only matches the 3%. Rules for matching funds vary, so check with your employer about qualifying for its contributions.  The IRS has contribution limits for 401(k) accounts. Check with your adminstrator to find out what that amount is.   

You’ll also want to consider the type of 401(k) you choose. They come in two varieties, the main differences being the tax implications and the schedule for accessing your funds. Chances are your company offers a traditional 401(k). Less common is a Roth 401(k). Here’s the breakdown of each:


401k typeTax rulesWithdrawal rules
  • Wages are contributed before taxes from each paycheck, like a deferred salary.
  • Taxable income drops by the amount you contribute.
  • You pay income taxes on contributions and earnings upon withdrawal.
  • No access to your funds before age 59 ½ or if you leave your employer at age 55 or older.
  • If you dip in early, expect a 10% penalty — on top of the usual tax bill.
  • Contributions are made with money that’s already been taxed.
  • No taxes paid upon withdrawal.
  • Better flexibility: free access to your money as long as you’ve held the account for 5 years.


Most companies allow you to enroll in a 401(k) right away, although some smaller employers might make you wait up to a year.  You can normally increase or decrease your contributions at any time. Don’t forget to select a beneficiary (the person who gets your money if you die).   If you’re married, your spouse is automatically the beneficiary.

Finally, if your company is on shaky ground, don’t fret. Your 401(k) is off-limits. If your company goes under, the plan would most likely be terminated. If that happens, you can roll the money over into a traditional IRA to avoid paying the 10% withdrawal penalty and income taxes.

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