401(k)
Basics explained.
When people hear “401(k),” they often know it has something to do with retirement, but not much beyond that. The truth is, a 401(k) is one of the most powerful tools available for building long-term wealth and the earlier you understand it, the bigger advantage you have.
What is a 401(k)?
A 401(k) is a retirement savings plan offered by many employers. It lets you set aside a portion of your paycheck:
Traditional 401(k): Contributions are made before taxes, lowering your taxable income now. You’ll pay tax later when you withdraw in retirement.
Roth 401(k): Contributions are made after taxes, so there’s no upfront tax break, but withdrawals in retirement are tax-free
Think of it like this: it’s a special bucket for retirement money that comes with tax benefits and often free money from your employer.
How Contributions Work
You choose what percentage of your paycheck goes into your 401(k).
Example: If you earn $3,000 a month and choose to contribute 5%, $150 will be automatically invested into your 401(k) each paycheck.
In 2025, the IRS allows you to contribute up to $23,000 per year to a 401(k) if you’re under 50.
Even if you can’t contribute much now, small contributions add up over time.
Employer Match = Free Money
Many employers offer a matching contribution, they’ll put money into your 401(k) if you do.
A common formula is:
Employer matches 50% of the first 6% you contribute. That means if you contribute 6% of your salary, your employer adds another 3%, basically a 50% return right away.
Rule of thumb: Always contribute at least enough to get the full match. Skipping the match is leaving free money on the table.
Where Does the Money Go?
Your 401(k) money doesn’t just sit in cash. You choose (or your employer provides default options) investments such as:
Target-date funds - adjust automatically as you get closer to retirement (beginner-friendly)
Stock funds- higher growth potential, more ups and downs
Bond funds- lower risk, more stability
Money market or stable value funds- very low risk, small growth
Your mix depends on your risk tolerance and how many years you have until retirement.
Taxes and Withdrawals
You generally can’t withdraw from your 401(k) until age 59½ without paying penalties (some exceptions exist)
At retirement, withdrawals from a traditional 401(k) are taxed as regular income.
Roth 401(k) withdrawals, if qualified, are tax-free.
Why Start in Your 20s?
Compound growth: The earlier you start, the more time your money has to grow. Even modest contributions can snowball into six figures by retirement.
Habits: Building the habit of contributing early makes it easier to stick with it as your income grows.
Employer match: It’s the closest thing to free money you’ll ever get.
Bottom Line: A 401(k) is not just a savings account, it’s a long-term wealth-building tool with built-in tax advantages and, in many cases, employer contributions. Starting early, even with small amounts, gives you a head start that most people don’t realize they have.
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