Everything You Need to Know About 401(k) Plans: A Q&A Guide

Written By: Derek Melvin

Planning for retirement can be overwhelming at times, but understanding your 401(k) plan is a crucial step towards securing your financial future. It is likely that your employer offers a 401(k) or 403(b) plan for their employees, so it is important that we know how to utilize these plans for retirement savings. In this comprehensive Q&A guide, we’ll break down everything you need to know about 401(k) plans.

For many out there, you may have a 403(b) plan, not a 401(k). The same points we discuss below for 401(k) plans will also apply to 403(b) plans.

What is a 401(k) plan?

A 401(k) plan is an employer-sponsored retirement savings account that allows employees to contribute a portion of their salary to save for retirement. Inside a 401(k), you will then invest yours and your employers contributions (if they offer matching) so that the money can grow over time.

401(k) plans offer tax advantages, making them a very attractive way for you to invest. You can contribute on a pre-tax basis or a Roth (after-tax) basis (more below). Then, your money grows tax-deferred, meaning that you do not pay any taxes while your investments grow over time.

If you have access to a 401(k) plan, especially if your employer offers matching contributions, this plan will likely be the first account you will want to use to start your retirement savings plan.

How does a 401(k) plan work?

When you enroll in a 401(k) plan, you choose a percentage of your salary to contribute. This amount is automatically deducted from your paycheck and deposited into your 401(k) account. Many employers offer a matching contribution, which can significantly increase your retirement savings.

It is important to understand how your employer matching works to ensure that you are taking full advantage of the match.

For example, an employer may match 50% of your contributions, up to 3%. Therefore, you need to contribute 6% to receive the full 3% match.

There are many different ways employer matching can be structured, so it is important to talk to a financial advisor to assist with your benefits or to speak to your HR directly to ensure you are understanding how to get the full employer match contributions.

What are the types of 401(k) plans?

There are two main types of 401(k) plans: traditional and Roth.

Traditional (pre-tax) 401(k): Contributions are made with pre-tax dollars, reducing your taxable income for the year. Withdrawals during retirement are taxed as ordinary income.
Roth 401(k): Contributions are made with after-tax dollars, meaning there’s no tax deduction in the contribution year. Qualified withdrawals during retirement are tax-free.

If you want to learn more about whether pre-tax or Roth contributions are a good fit for your financial situation, you can visit a recent blog post we posted breaking down the differences.

This is also something that would be important to discuss with a professional who knows your financial situation and can provide recommendations on the most tax efficient way for you to invest.

What are the 401(k) contribution limits for 2025?

For 2025, the contribution limit for employees under 50 is $23,500. For those aged 50 and above, the limit is $31,000, which includes catch-up contributions.

It is important to revisit your contribution percentage to ensure that you are on pace to max out contributions if you are able.

For example, if you make $200,000 of gross income, you will need to 12% ($23,500 / $200,000) starting January 1^st to max out your contributions for the year.

Your employer will automatically stop your contributions once you hit the maximum. In the example above, you can contribute much more than 12% if you would like, you would just hit the maximum earlier in the year than if you did 12%.

What are the benefits of a 401(k) plan?

Participating in a 401(k) plan offers several benefits:

Tax Advantages: Contributions to a traditional (pre-tax) 401(k) reduce your taxable income, and earnings grow tax deferred. Roth 401(k) contributions grow tax-free.
Employer Match: Many employers match a portion of your contributions, providing free money for your retirement.
Automatic Savings: Contributions are automatically deducted from your paycheck, making it easier to save consistently.
Investment Options: 401(k) plans offer a variety of investment options, including mutual funds, stocks, and bonds.

What are the investment options in a 401(k) plan?

401(k) plans typically offer a range of investment options, including:

Mutual Funds: These funds pool money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities.
Target-Date Funds: These funds automatically adjust the asset mix based on a target retirement date.
Company Stock: Some plans offer the option to invest in the employer’s stock.
Bond Funds: These funds invest in bonds and are generally considered less risky than stock funds.

How should I choose my 401(k) investments?

When choosing your 401(k) investments, consider your risk tolerance, time horizon, and retirement goals. Diversifying your investments can help manage risk.

With your investment options, it is important that you understand the funds available for you to invest and how to appropriately choose your investment options based on your goals and retirement timeline. If you would like to meet with one of our financial advisors to look through your specific 401(k) investment options to ensure that is appropriate for your situation, please feel free to reach out to us and we would be glad to get an initial meeting scheduled.

When can I withdraw from my 401(k) without penalty?

You can start withdrawing money from your 401(k) without penalty at age 59½. Withdrawals before this age may be subject to a 10% early withdrawal penalty, in addition to regular income taxes.

What happens to my 401(k) if I change jobs?

If you change jobs, you have several options for your 401(k):

Leave it with your old employer: If your balance is above a certain amount, you can leave your 401(k) with your former employer.
Roll it over to your new employer’s plan: If your new employer offers a 401(k) plan, you can roll over your balance into the new plan.
Roll it over to an IRA: You can roll over your 401(k) into an Individual Retirement Account (IRA).
Cash it out: While you can cash out your 401(k), this option is generally not recommended due to taxes and potential penalties.

Can I borrow from my 401(k)?

Many 401(k) plans allow you to borrow from your account, but there are rules and limitations. Generally, you can borrow up to 50% of your vested balance, up to a maximum of $50,000. Loans must be repaid with interest, typically within five years.

What happens to my 401(k) when I retire?

When you retire, you can start taking distributions from your 401(k). You can choose to take lump-sum distributions, periodic withdrawals, or purchase an annuity. It’s important to plan your withdrawals to ensure your savings last throughout retirement.

In Summary

A 401(k) or 403(b) plan will likely be the centerpiece of your retirement savings plan. Understanding how to utilize these plans as soon as possible can set you up for greater likelihood of success for being able to retire when you want to. With these plans offering major tax advantages to invest, it is key to get money into these plans when you are younger to let the power of compounding interest do its thing.

With that said, a 401(k) or 403(b) plan is just one of the money investment accounts out there and it is likely you will need multiple accounts to reach your retirement savings goals, especially if you are a high-income earner. If you have questions on your 401(k) or 403(b), or your retirement savings plan as a whole, please contact us to setup an initial meeting to discuss your financial plan in more detail.

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Investing involves the risk of loss, including total loss of principal. This should not be construed as individualized investing advice. Consult with your investment advisor to develop an appropriate investment strategy for your circumstances.