What is a 401(k)?
A 401(k) is an employer-sponsored retirement savings plan that allows employees to save and invest for retirement on a tax-advantaged basis. It's named after section 401(k) of the Internal Revenue Code.
Key 401(k) Benefits
- Tax Advantages: Contributions reduce taxable income (Traditional) or grow tax-free (Roth)
- Employer Match: Free money from your employer—typically 3-6% of salary
- High Contribution Limits: Save much more than IRAs allow
- Automatic Savings: Payroll deductions build wealth effortlessly
- Creditor Protection: Generally protected from bankruptcy and lawsuits
2026 Contribution Limits
| Contribution Type | 2026 Limit | Notes |
|---|---|---|
| Employee Contributions (Under 50) | $23,500 | Up from $23,000 in 2025 |
| Catch-Up (Ages 50-59, 64+) | $7,500 | Total: $31,000 |
| Super Catch-Up (Ages 60-63) | $11,250 | Total: $34,750 |
| Total Limit (Employee + Employer) | $70,000 | Or 100% of compensation |
| Total + Catch-Up | $77,500 | For those 50+ |
New Super Catch-Up Provision
Starting in 2025, workers ages 60-63 can contribute an additional $11,250 (instead of $7,500), bringing their total employee contribution to $34,750. This provides a significant boost for those nearing retirement.
Maximizing Employer Match
The employer match is essentially free money—the best guaranteed return in investing.
Common Match Formulas
| Match Type | Example | Your Contribution to Max |
|---|---|---|
| 100% match up to 3% | $60k salary = $1,800 match | 3% of salary |
| 50% match up to 6% | $60k salary = $1,800 match | 6% of salary |
| 100% match up to 6% | $60k salary = $3,600 match | 6% of salary |
| Dollar-for-dollar up to $5,000 | $5,000 match | $5,000 |
Rule #1: Always Get the Full Match
Not contributing enough to get the full employer match is leaving money on the table. A 50% match is an immediate 50% return on your money—you won't find that anywhere else.
Watch for Vesting Schedules
Employer contributions may vest over time:
- Immediate vesting: You own the match right away
- Cliff vesting: 100% vests after X years (usually 3)
- Graded vesting: 20% per year over 5-6 years
Choosing Investments
Typical 401(k) Investment Options
- Target-Date Funds: All-in-one portfolios that adjust with age
- Index Funds: Low-cost funds tracking market indices
- Actively Managed Funds: Higher fees, aim to beat the market
- Company Stock: Your employer's stock (limit exposure)
- Stable Value/Money Market: Conservative, low-return options
Recommended Investment Strategy
For Simplicity: Target-Date Fund
Choose a fund matching your expected retirement year (e.g., "Target 2055" if retiring around 2055). It automatically diversifies and becomes more conservative as you age.
For Control: Build Your Own Portfolio
| Age | Stocks | Bonds | Example Allocation |
|---|---|---|---|
| 20s-30s | 90% | 10% | 70% US Stock Index, 20% Int'l Stock, 10% Bond |
| 40s | 80% | 20% | 60% US Stock, 20% Int'l, 20% Bond |
| 50s | 70% | 30% | 50% US Stock, 20% Int'l, 30% Bond |
| 60s | 50-60% | 40-50% | 40% US Stock, 15% Int'l, 45% Bond |
Key Investment Principles
- Minimize fees: Choose low-cost index funds when available
- Diversify: Don't put everything in one fund or company stock
- Stay the course: Don't panic-sell during market downturns
- Rebalance annually: Return to target allocation once per year
Traditional vs Roth 401(k)
| Feature | Traditional 401(k) | Roth 401(k) |
|---|---|---|
| Tax on Contributions | Pre-tax (reduces current taxes) | After-tax (no current deduction) |
| Tax on Growth | Tax-deferred | Tax-free |
| Tax on Withdrawals | Taxed as ordinary income | Tax-free (if qualified) |
| Best If... | Current tax rate > retirement rate | Current tax rate < retirement rate |
General Guidelines
- Early career (lower income): Favor Roth—pay taxes now at low rates
- Peak earning years: Favor Traditional—maximize current deductions
- Uncertain: Split contributions between both for tax diversification
Common Mistakes to Avoid
1. Not Contributing Enough for the Match
This is literally leaving free money on the table. Even if money is tight, contribute at least enough to get the full employer match.
2. Being Too Conservative Young
With decades until retirement, young investors can afford stock market volatility. Being too conservative early means missing out on growth.
3. Too Much Company Stock
Holding more than 10-15% in employer stock creates concentration risk. If your company struggles, your job AND retirement savings are at risk (Enron effect).
4. Cashing Out When Changing Jobs
Taking a distribution triggers taxes plus a 10% penalty if under 59½. Roll over to an IRA or new employer's plan instead.
5. Ignoring Fees
A 1% higher fee can cost hundreds of thousands over a career. Always check expense ratios and choose low-cost options.
6. Not Increasing Contributions Over Time
When you get raises, increase your contribution rate. Many plans offer auto-escalation features.
401(k) Optimization Checklist
- Contribute at least enough to get the full employer match
- Choose low-cost index funds or an appropriate target-date fund
- Decide between Traditional and Roth based on your tax situation
- Limit company stock to under 10-15% of your 401(k)
- Increase contributions with each raise
- Never cash out when changing jobs—roll over instead
- Review and rebalance annually
References
3- TreasuryDirect (opens in a new tab) U.S. Treasury