What Is a 401(k) Retirement Savings Plan?
A 401(k) is a retirement plan sponsored by an employer that offers employees tax incentives to save money for retirement from their paychecks.
- (opens in new tab)
- (opens in new tab)
- (opens in new tab)
- Newsletter sign up Newsletter

If you go to work for a large private employer, chances are you will be offered a 401(k) account. This tax-friendly retirement plan allows you to save and invest for retirement through payroll deductions. Since its inception 40 years ago, the 401(k) has become the retirement plan of choice for many employers, which have moved away from providing traditional pension plans. In 2017, assets in 401(k)s totaled $5.3 trillion.
How does a 401(k) plan work?
Contributions to a traditional 401(k) are deducted from your paychecks before the money is taxed. You determine the pretax amount you invest each pay period, although the maximum 401(k) contribution you can make in 2018 is $18,500 if you’re younger than 50. If you’re age 50 or older, you can get an added savings boost by making up to a $6,000 catch-up contribution, which brings the annual maximum 401(k) contribution to $24,500. In 2019, the maximum annual 401(k) contribution increases by $500 to $19,000; the limit on catch-up contributions remains at $6,000. The money you save in a 401(k) account grows tax-deferred until you withdraw it in retirement. At that point, you will owe ordinary income tax on the withdrawals. If you take out money before age 59½, you generally will be hit with a 10% early-withdrawal penalty on top of taxes.
Employers typically provide a mix of mutual funds for you to invest in, including low-cost index funds that track the broad stock market and bond market. Other 401(k) investment options might include company stock, exchange-traded funds (ETFs) and variable annuities.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The most popular investment options in 401(k)s are target-date funds, which held $1 trillion in assets as of last year. With target-date funds, you choose a fund whose name contains the date closest to your expected year of retirement. The fund manager will invest aggressively when you’re younger, and the fund will gradually become more conservative as you near retirement age.
Auto-enrollment in 401(k)s
Even if you don’t actively enroll in a 401(k), your employer might automatically do it for you. According to a 2018 survey by Willis Towers Watson, 73% of employers polled automatically enroll new employees in a 401(k), up from 52% in 2009.
With auto-enrollment, employers deduct, say, 3% or 4% from your pay and invest it in a 401(k) – often in a target-date fund based on your age. Some employers also automatically increase your annual contributions gradually, often stopping once you are putting aside 8% to 10% of your pay. You can always opt out.
Plans that use both auto-enrollment and auto-escalation of contributions have higher savings rates than those that don’t. According to a December 2017 survey by the Defined Contribution Institutional Investment Association, 70% of plans using auto-enrollment and auto-escalation features had savings rates of 10% or more among employees. Only 44% percent of plans that don’t have those features reached that level of savings.
Extra benefits of a 401(k)
In addition to building a nest egg for retirement, stashing money in a 401(k) lowers your current tax bill. That’s because your pretax contributions reduce the amount of current wages subject to tax. For example, if your monthly income is $4,500 and you contribute $1,000 of that to your 401(k), only $3,500 of your paycheck will be subject to tax.
Note that some employers offer employees the option to open a Roth 401(k) account instead of a traditional 401(k). As with a Roth IRA, contributions to a Roth 401(k) are made with after-tax dollars. The big benefit to workers is that withdrawals made in retirement aren’t subject to tax. Contribution limits to a Roth 401(k) are the same as a traditional 401(k).
Another benefit of a 401(k) is that many employers encourage participation in the plan by matching workers’ contributions by, say, 50 cents for every dollar an employee contributes -- up to 6% of pay. Some employers even contribute to workers’ 401(k)s regardless of whether employees put in their own money. On average, companies contribute 4.8% of an employee’s pay to the employee’s 401(k) account, according to the Plan Sponsor Council of America.
Make sure you contribute enough to receive your full employer match. Otherwise, you are leaving free money on the table. And if you’re not already maxing out your contributions, don’t forget to ramp up your savings with each pay raise until you reach the max.
Stay on top of 401(k) fees
Not all 401(k)s are created equal, and high fees can quickly eat away at an account balance. Pay close attention to the expense ratios of your investments and the administration fees charged by your plan. Check your statements or log in to your 401(k) account to research expenses ratios and fees.
According to a recent study from brokerage firm TD Ameritrade, 37% of participants thought their 401(k) plan didn’t charge any fees, and 22% weren’t sure how much the fees were. The average fee for a large-company plan is 1% of assets, according a study from BrightScope, which rates 401(k)s. Anything more and you’re paying too much, BrightScope says.
For help calculating the fees you pay, try TD Ameritrade’s free 401(k) Fee Analyzer (opens in new tab). You’ll need to type in your fund information or provide your 401(k) account login credentials to allow read-only access to your account. And check the BrightScope website (opens in new tab) to see how your plan ranks against its peers on fees and other factors. If your 401(k) plan fares poorly, let your company’s benefits department know.
Rivan joined Kiplinger on Leap Day 2016 as a reporter for Kiplinger's Personal Finance magazine. She's now a staff writer for the magazine and helps produce content for Kiplinger.com. A Michigan native, she graduated from the University of Michigan in 2014 and from there freelanced as a local copy editor and proofreader, and served as a research assistant to a local Detroit journalist. Her work has been featured in the Ann Arbor Observer and Sage Business Researcher.
-
-
Fed Raises Interest Rates Yet Again: What the Experts Are Saying
Federal Reserve The Fed's quarter-point rate hike was welcomed by the market and market pros, alike.
By Dan Burrows • Published
-
Stock Market Today: Stocks Swing Higher After Powell Presser
The Fed raised rates by 0.25%, as expected, and Powell promised to "stay the course until the job is done."
By Karee Venema • Published
-
Best Foreclosure Sites for Finding Properties
Making Your Money Last Wondering how to find foreclosed homes for sale for your next residence or to flip for a profit? These websites will guide you to foreclosures and real estate owned properties to buy.
By Bob Niedt • Last updated
-
As the Market Falls, New Retirees Need a Plan
retirement If you’re in the early stages of your retirement, you’re likely in a rough spot watching your portfolio shrink. We have some strategies to make the best of things.
By David Rodeck • Published
-
Retirees: Your Next Companion May Be a Robot
happy retirement Robots may help fill the gap left by a shortage of humans to help older adults live independently.
By Alina Tugend • Published
-
Is Relief from Shipping Woes Finally in Sight?
business After years of supply chain snags, freight shipping is finally returning to something more like normal.
By David Payne • Published
-
Using Your 401(k) to Delay Getting Social Security and Increase Payments
retirement Your 401(k) can be a bridge from retirement to higher monthly income.
By Elaine Silvestrini • Published
-
How Do I Stop Robocalls From Scamming Me?
retirement The scammers have automated their efforts to separate you from your money. We have ways to make it stop.
By Elaine Silvestrini • Published
-
A Kiplinger-ATHENE Poll: Retirees Are Worried About Money
Making Your Money Last Concerns about recession, inflation and health care costs weigh on retirees and near retirees.
By the editors of Kiplinger's Personal Finance • Published
-
Grandparent Scams Get Victims in Their Hearts
Scams If you get a call from someone who claims to be your grandchild in trouble and needing money right away, be wary. Don’t send any money or give any information until you verify the story.
By Elaine Silvestrini • Published