How Does a 401(k) Work?
A 401(k) is a tax-advantaged retirement savings plan offered by employers in the United States. Employees contribute a portion of their pre-tax salary (in a traditional 401(k)) or after-tax salary (in a Roth 401(k)) directly from each paycheck. The money is invested in a menu of options — typically mutual funds and index funds — and grows tax-deferred until withdrawal in retirement.
The fundamental advantage of a 401(k) is the combination of tax deferral and employer matching. In a traditional 401(k), every dollar you contribute reduces your taxable income dollar-for-dollar in the year you contribute it. If you're in the 22% tax bracket and contribute $10,000, you effectively save $2,200 in taxes that year — the government subsidizes your retirement savings. Your investments then grow without being reduced by annual taxes on dividends, interest, or capital gains.
In a Roth 401(k), contributions are made with after-tax money, but all growth and qualified withdrawals in retirement are completely tax-free. Whether traditional or Roth makes more financial sense depends on whether you expect your tax rate to be higher now or in retirement — a comparison that's genuinely difficult to predict over decades.
Understanding Employer Match — A Worked Example
Employer matching is one of the most valuable benefits in compensation packages, yet many employees fail to capture all of it. A common match structure is "50% match up to 6% of salary." Here's exactly what that means:
You contribute 10% of salary = $6,000/year
Match applies to first 6% of salary = first $3,600 of your contributions
Employer match = 50% × $3,600 = $1,800/year in free money
If you only contributed 4% ($2,400), the match would be 50% × $2,400 = $1,200 — you'd leave $600/year on the table.
If you contributed 6% exactly ($3,600), the match would be 50% × $3,600 = $1,800 — you've captured the full match.
That $1,800/year in employer contributions is an immediate 50% return on the first $3,600 you contribute — before any investment growth occurs. No investment can reliably beat that return on day one. This is why capturing the full employer match is universally recommended as the first priority in retirement saving.
2026 IRS Contribution Limits
The IRS sets annual limits on how much can be contributed to 401(k) and similar workplace retirement plans. For 2026 (source: IRS Notice 2025-67):
Employee elective deferral limit: $24,500
Catch-up contribution, age 50–59 and 64+: $8,000 (total: $32,500)
Enhanced catch-up, ages 60–63: $11,250 (total: $35,750)
Combined employee + employer (Section 415(c)): $72,000
These limits are adjusted annually for inflation each November. Check irs.gov for current limits.
The enhanced catch-up provision for ages 60–63 was introduced by SECURE 2.0 Act (2022) and took effect in 2025. Workers in this specific age window can contribute an additional $11,250 on top of the $24,500 base limit, for a total of $35,750. This window was designed to give workers nearing retirement an extra opportunity to boost savings in the years immediately before they need the money.
Why Starting Early Makes Such a Large Difference
The most important variable in 401(k) projections is not the contribution rate or the investment return — it's time. Consider two workers with identical salaries, contribution rates, and investment returns, but starting at different ages:
Contributes $500/month at 7% return → Final balance: approximately $1,310,000
Investor B — starts contributing at age 35, retires at 65 (30 years)
Contributes $500/month at 7% return → Final balance: approximately $590,000
Investor A contributed $60,000 more but ended up with $720,000 more. Those extra 10 years cost $60,000 in contributions and generated over 12× that in compounded growth.
This isn't financial advice — it's mathematics. The early contributions have more time to compound, and compound interest grows exponentially rather than linearly. The money contributed in year 1 of a 40-year timeline has 40 years to grow, while the money contributed in year 1 of a 30-year timeline only has 30 years. That difference alone creates the gap.
Traditional vs. Roth 401(k): The Key Difference
Both traditional and Roth 401(k) accounts grow tax-deferred — you owe no annual taxes on dividends, interest, or capital gains inside the account. The difference is in when you pay taxes:
Traditional 401(k): Contributions come from pre-tax dollars, reducing your taxable income now. Withdrawals in retirement are taxed as ordinary income. If you're in a high tax bracket today and expect a lower rate in retirement, traditional often wins.
Roth 401(k): Contributions come from after-tax dollars — no immediate tax deduction. But qualified withdrawals in retirement, including all the growth, are completely tax-free. If you're early in your career in a lower tax bracket and expect higher rates later (or if you expect taxes in general to rise), Roth is often the better choice.
Many financial planners recommend using both — enough traditional contributions to reduce your current taxable income to the next bracket down, and Roth contributions beyond that. This calculator applies to both, since the contribution limits and employer match mechanics are the same regardless of which type you choose.
What This Calculator Does Not Include
- Taxes on withdrawal: In a traditional 401(k), all withdrawals in retirement are taxed as ordinary income. This calculator projects your nominal balance — your after-tax withdrawal amount will be lower.
- Investment fees: Fund expense ratios (typically 0.03–1%+ per year) reduce your effective return. A 1% annual fee on a $300,000 portfolio costs $3,000/year — and that $3,000 can no longer compound.
- Required Minimum Distributions (RMDs): Traditional 401(k) accounts require minimum withdrawals beginning at age 73 (under SECURE 2.0). Roth 401(k)s are exempt from RMDs during the owner's lifetime if rolled to a Roth IRA.
- Market volatility: This calculator assumes a constant annual return. Real markets are volatile — 7% average includes years of -30% and +40%. Sequence-of-returns risk matters most near retirement.
- Social Security and other income: Your 401(k) is likely one of multiple retirement income sources. A complete retirement plan includes Social Security projections, other savings, pensions, and expected expenses.
Frequently Asked Questions
For 2026, the IRS employee elective deferral limit for 401(k), 403(b), and 457 plans is $24,500 (up from $23,500 in 2025). Workers aged 50 and older can make an additional catch-up contribution of $8,000, bringing their total to $32,500. Workers specifically aged 60, 61, 62, or 63 qualify for an enhanced catch-up of $11,250 instead, for a total of $35,750. The combined employee-plus-employer annual limit under Section 415(c) is $72,000. Source: IRS Notice 2025-67.
At a minimum, contribute enough to capture your full employer match — this is free money with an immediate guaranteed return that no investment can beat. Beyond the match, a common guideline is to save 10–15% of gross income for retirement across all accounts combined. If your employer matches 50% up to 6%, contributing at least 6% captures the full match (giving you a total savings rate of 9% between employee and employer). Maxing out at $24,500/year (2026) is ideal if your budget allows it, particularly in your peak earning years.
The most common 401(k) match structure is 50% of contributions up to 6% of salary — effectively 3% of salary in free employer contributions. Some employers offer 100% match up to 3–6% of salary, which is more generous. The national average employer 401(k) contribution was approximately 4.3% of salary in recent years. Any match is valuable since it represents an immediate return on your contributions, but 100% match up to 6% of salary (6% of salary in free money) is considered excellent.
Maxing out ($24,500 in 2026) makes sense once you've (1) captured the full employer match, (2) paid off high-interest debt (credit cards, personal loans above ~7%), and (3) built a 3–6 month emergency fund. After those foundations, maximizing tax-advantaged contributions is generally the next most efficient move for long-term wealth building. The tax savings compound alongside the investment returns, creating a powerful dual benefit. If you can't max out now, increase your contribution rate by 1% each time you get a raise — you won't notice the reduction in take-home pay.
Both types hold the same investments and have the same contribution limits. The difference is tax timing: traditional 401(k) contributions are pre-tax (reducing your income tax bill now, but withdrawals are taxed in retirement), while Roth 401(k) contributions are after-tax (no deduction now, but withdrawals in retirement are tax-free). The math favors traditional if you're in a higher tax bracket now than you'll be in retirement, and Roth if the opposite is true. Since future tax rates are uncertain, many advisors recommend splitting contributions between both to hedge.
When you leave an employer, you have several options: (1) Roll the balance into your new employer's 401(k), (2) roll it into a traditional or Roth IRA for more investment options, (3) leave it in your former employer's plan if they allow it, or (4) cash it out — though cashing out triggers income tax plus a 10% early withdrawal penalty if you're under 59½. Rolling over to an IRA or new 401(k) is almost always the best choice, as it preserves the tax-advantaged status and keeps your money compounding.