What Is a 401(k) and Should You Contribute?

A 401(k) is one of the most powerful tools for building long-term wealth — but many people either don't use it, or don't use it correctly. Here's what you need to know.

What Is a 401(k)?

A 401(k) is a retirement savings account offered through your employer. You contribute a portion of your paycheck before (or after) taxes, it grows over time through investments, and you withdraw the money in retirement.

The name comes from the section of the US tax code that created it.

Why It's Powerful

Tax advantages: Traditional 401(k) contributions come out of your paycheck before income tax. If you earn $70,000 and contribute $7,000 to your 401(k), you're only taxed on $63,000. You defer the taxes until retirement when you may be in a lower bracket.

Employer match: Many employers match your contributions up to a percentage of your salary. This is free money — the highest guaranteed return available.

Compound growth: Your investments grow tax-deferred for decades. The compounding effect over 30–40 years is significant.

The One Mistake Most People Make

Not contributing enough to get the full employer match.

If your employer matches 50% of contributions up to 6% of your salary, contributing only 3% means you're leaving 1.5% of your salary as free money on the table. Every year.

The first goal of any 401(k) strategy should be: contribute at least enough to get the full employer match.

Traditional 401(k) vs. Roth 401(k)

Many employers now offer both options:

Traditional 401(k):

• Contributions are pre-tax (reduce your taxable income now)
• You pay taxes when you withdraw in retirement
• Better if you expect to be in a lower tax bracket in retirement

Roth 401(k):

• Contributions are after-tax (no immediate tax reduction)
• Withdrawals in retirement are tax-free
• Better if you expect to be in a higher tax bracket in retirement, or if you're early in your career with lower income now

If you're young and in a lower tax bracket, Roth is often the better choice. If you're in a high tax bracket now, traditional provides immediate relief.

How Much Should You Contribute?

Priority order:

1. Contribute enough to get the full employer match (never leave this on the table)
2. Max out an IRA if possible ($7,500/year in 2026, $8,600 if 50+)
3. Go back to the 401(k) and increase contributions

2026 contribution limits (IRS):

• Employee contribution: $24,500/year
• If 50+: additional $8,000 catch-up contribution
• If 60–63: enhanced catch-up of $11,250

Limits change annually — check IRS.gov for the current year.

Most people can't max it out immediately — that's fine. Start at whatever gets the employer match and increase by 1% per year. You'll barely notice 1% and it adds up significantly over decades.

What Happens to Your 401(k) If You Leave?

It's yours. You can:

• Leave it with your former employer's plan (if allowed)
• Roll it over to your new employer's 401(k)
• Roll it over to an IRA (often the best option — more investment choices, lower fees)
• Cash it out — not recommended (taxes + 10% early withdrawal penalty before age 59½)

Start contributing to your 401(k) as early as possible. The math strongly favours starting now over starting later.