What Is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan that lets employees contribute a portion of their wages. The money is then invested and can grow over time. Employers may also match contributions up to a certain dollar amount or percentage.

With proper management and consistent contributions, you may be able to use a 401(k) to help save up for life after your career. Let's learn more about the ins and outs of 401(k)s.

How 401(k) plans work

You typically sign up for a 401(k) through your employer and elect to contribute a portion of your income to the account. Your employer may match up to a certain percentage or dollar amount. For example, they might match contributions up to 5% of your salary. So, if you make $80,000 per year and contribute 5% of your salary, you will contribute $4,000 annually toward your 401(k). If your employer matches your contributions, they will contribute an additional $4,000 each year.

Employees can choose how to invest their contributions, often from a selection of mutual funds, stocks or bonds offered by the plan. You may also be able to choose target-date funds designed to minimize risk as you approach retirement.

There are two different types of 401(k) plans: traditional and Roth. With traditional 401(k) plans, you contribute pre-tax income and pay taxes when you withdraw the money during retirement. For Roth 401(k) plans, the taxes are paid upfront, and withdrawals during retirement are tax-free.

401(k) contribution limits

There are limits to how much individuals and their employers can contribute to a 401(k) each year, known as contribution limits.

Contribution limits are reviewed and sometimes adjusted annually to keep pace with factors like inflation and the cost of living. The Internal Revenue Service (IRS) reviews these factors each year and may increase contribution limits to help ensure that employees can continue to save enough for retirement. Since these limits are updated annually, you may want to review and adjust your contributions each year to ensure you are making the most of your 401(k).

Employees over a certain age may be eligible for catch-up contributions, allowing them to contribute more than the standard contribution limit. This may help individuals nearing retirement save more and potentially reduce their pre-retirement tax burden.

How much can you contribute to a 401(k) in 2026?

For 2026, the employee contribution limit for a 401(k) is $24,500. There's also a catch-up contribution of $8,000 for individuals aged 50 and over. Those aged 60-63 can benefit from an even larger catch-up contribution of $11,250 as of 2026.

For employees under 50, the limit for combined employee and employer contributions is 100% of the employee's annual salary or $72,000 (whichever is lower) for 2026. This limit is $80,000 for employees 50 and older, which includes catch-up contributions.

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

Both traditional 401(k) and Roth 401(k) plans are employer-sponsored retirement accounts that offer tax advantages, but they differ in how and when taxes are applied.

Let's take a close look at both types of plans and compare how each may benefit you depending on your income, tax bracket and retirement goals.

Traditional 401(k)

Contributions to a traditional 401(k) are made with pre-tax dollars. This reduces your taxable income in the year you contribute. The funds grow tax-deferred, and you pay taxes on the withdrawals during retirement.

A traditional 401(k) may make sense if you expect to be in a lower tax bracket in retirement or want to reduce your taxable income in the current year.

Here's a look at the key features of a traditional 401(k):

• Contributions are made with pre-tax dollars
• Reduces taxable income in the year you contribute
• Money invested in the account grows tax-deferred
• No income limit to participate
• No taxes are paid on contributions or earnings until you withdraw money in retirement

Roth 401(k)

Contributions to a Roth 401(k) are made with after-tax dollars, so you don't get an immediate tax break. Instead, you pay the taxes in the current year, but the money can grow tax-free. Withdrawals in retirement are also tax-free, as long as certain conditions are met.

A Roth 401(k) can make sense if you anticipate being in a higher tax bracket in retirement or if you'd prefer to take tax-free withdrawals in the future.

Let's consider the main characteristics of a Roth 401(k):

• Contributions are made with after-tax dollars
• No tax break on contributions, but investments can grow tax-free
• No income limit to participate
• Withdrawals in retirement are tax-free

Why contribute to your 401(k)?

Contributing to your 401(k) can be a valuable way to save for retirement. It may help to ensure you have funds set aside for the future, and the earlier you start, the more you could benefit. A 401(k) also offers a structured way to save for retirement through automated deductions, which can make it convenient to build your retirement savings over time.

Here are some benefits of contributing to your 401(k):

• Employer matching: Some employers match a dollar amount or percentage of your contributions, giving you extra money toward your retirement savings.
• High contribution limits: The contribution limits for 401(k) accounts tend to be higher than for other retirement accounts, like IRAs. This can help grow your retirement savings faster.
• Growth potential: The money you contribute to your 401(k) is invested, so it has the potential to grow over time
• Tax benefits: A 401(k) account can reduce your taxable income in the current year or allow for tax-free withdrawals in retirement, depending on the account you choose.

When can you withdraw from your 401(k)?

Generally, you can start withdrawing from your 401(k) without penalties once you reach the age of 59 1/2. Typically, you can take withdrawals as a lump sum or as periodic payments, depending on your plan's rules.

You'll typically need to pay taxes on any money you withdraw from a traditional 401(k), so it may make sense to space out withdrawals to have a manageable tax bill each year.

Withdrawals made before the age of 59 1/2 may be subject to a 10% early withdrawal tax penalty. In some circumstances, you may be able to make an early withdrawal without penalty, such as a qualifying disability, unreimbursed medical expenses, disaster recovery or if you separate from your employer during or after the year you turn 55 (or 50 for some employees).

Required minimum distributions for 401(k)s

Starting at age 73, you must begin taking required minimum distributions (RMDs) annually from your traditional 401(k). RMDs are mandatory withdrawals. Starting in 2024, Roth 401(k)s no longer require RMDs.

The amount of your RMD is based on your account balance and life expectancy. While you're required to take the minimum amount, you can withdraw more if you wish. Traditional 401(k) distributions are generally taxable, while Roth 401(k) distributions are not.

Contributing to a 401(k) and your financial future

When you're young and in the midst of your career, it can be challenging to think ahead to your retirement. But the sooner you start planning for it, the more prepared you'll be when it's time to start the next chapter of your life. A 401(k) can be an effective way to help save for retirement, especially if your employer offers matching contributions. Before you sign up, be sure to understand how deductions will be taken from your paycheck and how that will impact your take-home pay.

Disclosure: This article is for general educational purposes. It is not intended to provide financial advice. It also is not intended to completely describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products.