401(k)s are the most popular retirement savings plan. Approximately 70 million Americans1—or about 43% of the working population2—use one to invest money they'll live off in retirement.
But just because they're common doesn't mean they're well understood. Whether you're a veteran retirement saver or are just getting started, here's what you need to know about 401(k)s and how they work.
What is a 401(k)?
Named for the tax code section that created it, a 401(k) is an employer-sponsored retirement savings plan with special tax benefits. (The exact tax advantages depend on which kind of 401(k) contributions you make—more on that later.) Employers typically offer 401(k)s as part of a benefits package to attract and retain workers.
Not everyone has access to a 401(k). Depending on your industry, you may be able to contribute to a similar employer-sponsored retirement plan, like a 403(b) or 457(b), instead of a 401(k). Self-employed people can open a type of 401(k) on their own called a self-employed 401(k), and anyone who earns an income (or who is married to someone who does) can save for retirement—in addition to a 401(k) or in place of one—within an IRA.
How does a 401(k) work?
401(k)s let you contribute part of each paycheck into a retirement account, where you can generally invest your assets in various types of mutual funds, such as index funds or target date funds. The IRS requires that contributions are made by employers through paycheck reductions, meaning you can't make contributions by personal check.
The ability to invest for retirement is a major incentive to use a 401(k)—investing your money gives it a chance to benefit from compounding and a potential to grow over time. But 401(k)s also offer tax advantages. Unlike contributions to regular brokerage accounts, pre-tax contributions to a 401(k) are not taxed until you begin withdrawals in retirement. Unless an exception applies, distributions prior to turning 59½ may be subject to a 10% tax as an early distribution penalty in addition to federal income taxes. Depending on where you live, you may also be taxed at the state and local levels.
Some employers offer a second type of 401(k) called a Roth 401(k), in which you invest after-tax money today and don't pay income taxes on your withdrawals in retirement. Not sure which to pick? Find out whether contributing to a Roth or traditional 401(k)—or even both—makes sense for you.
401(k) advantages
401(k)s can be a helpful tool to fund a secure retirement. A few key benefits include:
Automation
The science is clear: We're more likely to save when we don't have to think about it.3 That's where 401(k)s shine. By automatically funneling money from your paycheck to your retirement savings, there's no opportunity to spend the money on anything else.
Employer contributions
A key advantage of 401(k)s is that your employer may also contribute to help you save for retirement. This typically comes in the form of a 401(k) match, aka when your company agrees to contribute a certain amount based on what you contribute. This may come in the form of a full, dollar-for-dollar match up to a certain percentage of your salary or a partial match, where your employer matches a fraction of what you contribute, such as 50%, up to a certain percentage of your salary.
Fidelity suggests aiming to contribute at least enough to get the full match amount.
Compounding
The potential snowball effect of compounding makes early saving or investing, particularly in tax-advantaged retirement accounts like a 401(k), that much more enticing since the earlier you start investing, the more compounded returns you can hope to make.
401(k) contribution limits
In 2026, you can contribute up to $24,500 pre-tax or Roth to your 401(k). Some plans may allow after-tax contributions up to the combined employee and employer limit of $72,000. If you're at least age 50 at the end of the calendar year, you can add a pre-tax or Roth catch-up contribution of $8,000 (or $11,250 if age 60–63, if your plan allows).
According to the SECURE 2.0 Act's higher earner rule, in 2026, catch-up contributions for earners whose FICA wages (typically Box 3 of Form W-2) exceed $150,000 in the previous tax year, must be designated as Roth after-tax contributions.
If your employer's plan does not offer a Roth contribution feature and you fall under the high-earner rule, you won't be able to make catch-up contributions to that plan.
Check with your plan sponsor to find out what catch-up contributions are available to you.
Most 401(k) plans have formulas built in to keep you from running over your annual maximum. If you do exceed the annual 401(k) contribution limit, you have until April 15 of the following year to withdraw the excess contributions. If you don't fix the mistake, you'll be taxed twice, once on the excess contributions in the current year and a second time upon taking withdrawals.
401(k) withdrawal rules
The federal government imposes some restrictions on when you can withdraw money from your 401(k). Generally, you must wait until you're at least age 59½ to access the money without paying a penalty. If you take a withdrawal earlier than that, you may owe a 10% penalty on top of income tax in all but a few circumstances. Those special exceptions include distributions after both reaching age 55 and separating from your employer; financial hardship, including but not limited to medical costs; and to prevent foreclosure.
The SECURE 2.0 Act added new exceptions to the early withdrawal penalty for 401(k) and other retirement plans, allowing qualifying withdrawals for domestic abuse, emergency expenses, and disaster relief—to go along with previous exceptions for birth and adoption.
One way to avoid paying the penalty and income taxes is by taking a loan from your 401(k), which some, but not all, plans allow. Keep in mind, however, that if you take a loan, the repayments will be deducted from your paycheck, which means your take-home pay will go down. Also know that any money you take out of your 401(k)—even for a short time—misses out on the opportunity to compound and grow. And if you change or leave your job, you might have to repay your loan in full in a very short time frame. If you can't repay the loan for any reason, the remaining loan balance is considered a taxable distribution from the account, and you may owe both taxes and a 10% penalty if you're under 59½.
Required minimum distributions (RMD)
According to the IRS, you must withdraw a certain amount of money each year starting at age 73 (this age will increase to 75 in 2033)—called required minimum distributions (RMDs)—from traditional IRAs and workplace retirement plans, including 401(k)s. One notable exception is that retirement plan account owners can delay taking their RMDs until the year in which they retire, unless they're a 5% owner of the business sponsoring the plan. This exception applies to workplace plans for still-working employees only, so owners of traditional IRA, SEP, and SIMPLE IRA accounts must begin taking RMDs once the accountholder reaches RMD age.
RMDs are equal to a percentage of your total eligible retirement account holdings as of December 31st the prior year and based on your life expectancy. The exact amount can be tricky to calculate, so consider reaching out to a financial or tax professional for help, or try Fidelity's online calculator. It's important to start withdrawing RMDs when required. Otherwise, you may end up owing a penalty of up to 25% of the amount not withdrawn—and that's in addition to taxes you may owe when you eventually take the withdrawal.
What happens to a 401(k) when I switch jobs?
You don't have to break up with your retirement plan when you and your employer part ways. You have several options for what to do with old 401(k)s: keeping your money where it is if your plan allows this, rolling it over to an IRA, transferring it to your new 401(k), or taking a withdrawal. Each has its pros and cons, which we cover in our guide to 401(k) rollovers.