Making the most of your 401(k) plan starts with differentiating between 401(k) types, choosing a contribution limit and selecting investments to help your account grow.
What is a 401(k) plan?
A 401(k) plan is an employer-sponsored account that allows employees to contribute a portion of their paycheck to save for retirement. Oftentimes, employers may match part of these contributions, but it is not required.
There are two main types of 401(k) plans: traditional and Roth. The traditional 401(k) is funded with pretax money, while the Roth 401(k) takes after-tax contributions. The type of plan you have determines what tax advantages you can receive, either now or during retirement.
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How does a 401(k) work?
Here’s a step-by-step process of how a 401(k) works:
- Employee contributions. Employees choose a percentage of their paycheck to go into their 401(k) account. It’s deducted automatically and deposited directly into their 401(k) account.
- Employer match. Many employers offer to match a percentage of these contributions. This free money can provide an extra boost of retirement savings.
- Investment selections. Options within a 401(k) plan can include stocks, bonds and mutual funds, but depend on your plan provider. A common investment option is target-date funds, which automatically adjust their investment mix from aggressive to conservative over time as the account owner approaches retirement age. Read more on how to invest your 401(k).
- Vesting schedule. While an employee’s contributions are always theirs, their employer’s match may be subject to a vesting schedule. This means the employee might not fully own the employer contributions until after a set period of time.
Starting 2025, employees are automatically enrolled in 401(k) and 403(b) plans by their employers once eligible. This rule doesn't apply to plans beginning before December 29, 2022. If your plan was started before this date, you'll need to opt-in manually. The contribution rate will increase annually until it reaches a maximum of 15%. This is a change ushered in by the Secure 2.0 Act, which aims to help workers save for retirement.
Types of 401(k) plans
The two main types of 401(k) plans — Roth and traditional — are differentiated by their tax advantages.
Roth 401(k) | Traditional 401(k) | |
|---|---|---|
Contribution limits | The 401(k) contribution limit applies to both accounts. You can contribute to both accounts in the same year, as long as you keep your total contributions under the cap. You can contribute $24,500 in 2026. People aged 50 and older can contribute an extra $8,000 as a catch-up contribution. Due to the Secure 2.0 Act, those aged 60, 61, 62 and 63 get a higher catch-up contribution of $11,250. | |
Tax treatment of contributions | Contributions are made after taxes, with no effect on current adjusted gross income. Employer matching dollars must go into a pretax account and are taxed when distributed. | Contributions are made pretax, which reduces your current adjusted gross income. |
Tax treatment of withdrawals | No taxes on qualified distributions in retirement. | Distributions in retirement are taxed as ordinary income. |
Withdrawal rules | Withdrawals of contributions and earnings are not taxed as long as the distribution is considered qualified by the IRS: The account has been held for five years or more and the distribution is:
Unlike a Roth IRA, you cannot withdraw contributions any time you choose. | Withdrawals of contributions and earnings are taxed. Distributions may be penalized if taken before age 59 ½, unless you meet one of the IRS exceptions. |
» Dive deeper: Our full explainer on traditional vs. Roth 401(k) plans
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Are you on track for
the future you want?
NerdWallet Wealth Partners created a free calculator to estimate your financial independence number, see where you stand, and find out how much you might need to close the gap.
NWWP is an SEC-registered investment adviser. Registration does not imply skill or training. The calculator is provided for informational and educational purposes only.
How much can I contribute to my 401(k)?
Every year, the IRS announces new contribution limits for retirement plans, including 401(k)s. In 2026, the 401(k) contribution limit for employees is $24,500 in 2026. People aged 50 and older can contribute an extra $8,000 as a catch-up contribution. Due to the Secure 2.0 Act, those aged 60, 61, 62 and 63 get a higher catch-up contribution of $11,250.
The total contribution limit in 2026, which includes both employee and employer contributions, is $72,000 or 100% of employee compensation, whichever is less. That combined limit is $80,000 for those age 50 and older, and $83,250 for those age 60 to 63.
A 401(k) plan offers higher annual contribution limits than individual retirement accounts (IRAs). An IRA tops out at $7,500 for 2026 ($8,600 if aged 50 and older).
Many financial professionals say you should aim to contribute 10% to 15% of your income to retirement savings. According to Fidelity Investments, the average 401(k) contribution rate was 14.2% in the third quarter of 2025, and that includes employer and employee contributions