What is a 401(k)?
A 401(k) is an employer-sponsored retirement plan where employees contribute a portion of their salary, investing in mutual funds, stocks, or bonds based on plan options.
How a Traditional 401(k) works
Pre-tax contributions: Your contributions are deducted pre-tax, lowering your taxable income for the year
Contribution Limits (2025):
- Max $23,500 (under 50)
- Max $30,000 (50 & older, including catch-up)
Employer match: Many employers match contributions, e.g., 50% up to 6% of salary, adding to your savings, tax-free until withdrawal.
Vesting: Employer contributions may require a set tenure before they fully belong to you.
How a Roth 401(k) works
After-tax contributions: Participants contribute after-tax dollars, unlike a traditional 401(k), where contributions are pre-tax.
Contribution limits (2025):
- Max $23,500 (under 50)
- Max $31,000 (50 & older, including catch-up)
Employer matches go to a traditional 401(k.), meaning those funds are tax-deferred and taxed upon withdrawal.
Tax benefits of a 401(k)
- Tax-deferred growth: Traditional 401(k) contributions and earnings grow tax-free until withdrawal, maximizing compounding.
- Taxation on withdrawals: Withdrawals in retirement are taxed as ordinary income, based on your tax bracket at that time.
- Roth 401(k) advantage: Contributions grow tax-free, and withdrawals (after 59½ and 5 years) are completely tax-free, ideal for those expecting a higher tax bracket in retirement.
Withdrawal rules
- After Age 59½ → Withdraw without penalty (but taxes apply to Traditional 401(k))
- Before Age 59½ → 10% penalty + income tax (exceptions apply)
- RMDs at Age 73 → Must withdraw a minimum amount annually
Avoid RMDs? Roll Roth 401(k) into a Roth IRA
401(k) for employers
Dual role contributions: Contribute as both an employee & employer
Contribution limits (2025): Employee + Employer = $70,000 max
Solo 401(k): Easier admin, no non-discrimination testing
Profit sharing options: Customize contributions based on company profits
Conclusion
401(k) is a powerful retirement tool, offering tax advantages, employer contributions, and long-term wealth growth.
Start early! More time = Bigger retirement savings
Reach out to FinStackk!