A 401k is an employer-sponsored retirement savings account that lets you invest pre-tax dollars — meaning the money comes out of your paycheck before income taxes are calculated. It’s one of the most powerful wealth-building tools available to employees, yet many people don’t fully understand how it works.
How a 401k saves you money on taxes
If you earn $60,000 and contribute $6,000 to a traditional 401k, your taxable income becomes $54,000. If you’re in the 22% tax bracket, that’s $1,320 saved in taxes immediately. Your investments grow tax-deferred — you don’t pay taxes on gains until you withdraw in retirement, when you’ll likely be in a lower tax bracket.
The employer match — free money
Many employers match your contributions up to a certain percentage — commonly 3%–6% of your salary. If your employer matches 100% of the first 4% you contribute, and you earn $60,000, that’s $2,400 in free money per year — a 100% instant return. Not contributing enough to get the full match is leaving free money on the table.
Traditional 401k vs Roth 401k
Traditional 401k: contributions are pre-tax, you pay taxes on withdrawals in retirement. Roth 401k: contributions are after-tax, but withdrawals in retirement are completely tax-free. If you expect to be in a higher tax bracket in retirement, the Roth option is often better.
2025 contribution limits
For 2025, you can contribute up to $23,500 to a 401k ($31,000 if you’re 50 or older). Your employer’s match doesn’t count toward this limit. Most financial advisors recommend contributing at least enough to get the full employer match, then maxing out a Roth IRA, then coming back to max the 401k if possible.
What happens when you leave a job?
Your 401k money is yours (though employer match contributions may have a vesting schedule). When you leave a job, you can roll the 401k into your new employer’s plan or into an IRA. Don’t cash it out — the taxes and 10% early withdrawal penalty will cost you 30%–40% of the balance immediately.