401(k) (US)
A US employer-sponsored retirement savings plan allowing employees to contribute pre-tax or Roth after-tax dollars from their paycheck, often with an employer matching contribution, governed by Section 401(k) of the Internal Revenue Code.
What Is a 401(k)?
Key Takeaways
- ✓A 401(k) is a tax-advantaged retirement savings plan sponsored by an employer, named after Section 401(k) of the Internal Revenue Code.
- ✓Employees contribute a percentage of their paycheck on a pre-tax basis (reducing current taxable income) or as Roth contributions (taxed now, tax-free in retirement).
- ✓The 2025 employee contribution limit is $23,500, with a catch-up contribution of $7,500 for those 50 and older, and a new "super catch-up" of $11,250 for those aged 60 to 63.
- ✓About 86% of employers that offer a 401(k) provide an employer match, most commonly matching 50% of employee contributions up to 6% of salary (Vanguard, 2024).
- ✓Total 401(k) assets in the US exceed $7.4 trillion, making it the largest employer-sponsored retirement savings vehicle in the country (ICI, 2024).
A 401(k) is a retirement savings plan that lets employees set aside a portion of their paycheck before taxes are taken out. The money goes into an investment account where it grows tax-deferred until the employee withdraws it in retirement (typically after age 59 and a half). Most employers sweeten the deal by matching a portion of the employee's contributions, which is essentially free money added to the employee's retirement account. The 401(k) plan was born from an obscure provision in the Revenue Act of 1978, and benefits consultant Ted Benna is credited with recognizing its potential as a retirement savings vehicle in 1980. It wasn't designed to replace pensions. It was supposed to supplement them. But as companies shifted away from defined-benefit pensions through the 1980s and 1990s, the 401(k) became the primary retirement plan for most American workers. Today, over 73 million Americans actively contribute to a 401(k), and total plan assets exceed $7.4 trillion. For employers, offering a 401(k) is practically mandatory for attracting professional talent. For employees, it's often the single largest financial decision they'll make outside of buying a home.
How a 401(k) Works
The mechanics of a 401(k) involve three parties: the employee (who contributes), the employer (who may match and who sponsors the plan), and the plan administrator (who manages investments, recordkeeping, and compliance).
Employee contributions
Employees choose a contribution rate, typically expressed as a percentage of gross salary (for example, 6%, 10%, 15%). The contribution is deducted from each paycheck before federal and state income taxes (for traditional pre-tax contributions) or after taxes (for Roth contributions). In 2025, employees can contribute up to $23,500 per year. Those aged 50 and over can add a $7,500 catch-up contribution ($31,000 total). Under SECURE 2.0, employees aged 60 to 63 get an enhanced catch-up limit of $11,250 ($34,750 total). Employees can change their contribution rate at any time (most plans allow changes to take effect within one to two pay periods). Financial advisors commonly recommend contributing at least enough to capture the full employer match.
Employer matching contributions
The employer match is the most valuable feature of a 401(k) for employees. The most common match formula is 50% of employee contributions up to 6% of salary. If an employee earns $100,000 and contributes 6% ($6,000), the employer adds $3,000 (50% of $6,000). That's a 50% instant return on the employee's contribution. Other common formulas include dollar-for-dollar match up to 3% of salary, 50% match up to 4% of salary, and flat dollar amounts regardless of employee contribution. About 14% of employers don't match at all, but the trend is toward matching: SECURE 2.0 created tax credits to incentivize small employers to start plans with matching contributions. The total combined contribution (employee plus employer plus any profit-sharing) can't exceed $70,000 in 2025 ($77,500 for those 50+).
Vesting schedules
Employee contributions are always 100% vested immediately: the money is theirs from day one. Employer matching contributions often follow a vesting schedule that requires the employee to stay for a certain period before the match is fully theirs. Common vesting schedules include cliff vesting (0% vested until a specific date, then 100%, typically 3 years) and graded vesting (vesting increases incrementally, such as 20% per year over 5 years or 33% per year over 3 years). Vesting is a retention tool. Employees who leave before full vesting forfeit the unvested employer contributions. These forfeitures are recycled by the employer to reduce future matching costs or cover plan expenses.
Types of 401(k) Plans
Not all 401(k) plans are structured the same way. The type of plan affects testing requirements, contribution limits, and administrative burden.
Traditional 401(k)
This is the standard plan. Employees make pre-tax contributions, and the employer may match. Traditional plans must pass annual non-discrimination tests (ADP and ACP tests) to ensure highly compensated employees (HCEs) don't disproportionately benefit compared to non-highly compensated employees (NHCEs). If the plan fails testing, HCE contributions may be refunded or limited. In 2025, an HCE is defined as someone earning more than $160,000 in the prior year.
Safe Harbor 401(k)
Safe Harbor plans automatically pass non-discrimination testing by requiring the employer to make a minimum contribution. The two common Safe Harbor options are: a matching contribution of 100% of the first 3% plus 50% of the next 2% of salary, or a non-elective contribution of 3% of salary for all eligible employees regardless of whether they contribute. Safe Harbor contributions must be 100% vested immediately. This plan type is popular with small and mid-size companies where a few highly paid owners or executives would otherwise cause testing failures. The guaranteed pass eliminates the risk of refunding HCE contributions.
SIMPLE 401(k)
Designed for employers with 100 or fewer employees. The SIMPLE 401(k) has lower contribution limits ($16,500 in 2025 with a $3,500 catch-up for those 50+) and requires the employer to either match dollar-for-dollar up to 3% of salary or make a 2% non-elective contribution. Like Safe Harbor plans, SIMPLE 401(k)s are exempt from non-discrimination testing. They're simpler to administer but less flexible than traditional or Safe Harbor plans.
Solo 401(k)
For self-employed individuals or business owners with no employees other than a spouse. The solo 401(k) allows contributions as both the employee (up to $23,500) and employer (up to 25% of net self-employment income), with a combined limit of $70,000 in 2025. This plan type is common among freelancers, consultants, and small business owners. It offers the highest contribution limits of any retirement plan available to self-employed individuals.
401(k) Investment Options
Employees choose how to invest their 401(k) balance from a menu of options selected by the plan sponsor and fiduciary. The quality and variety of investment options is a significant factor in plan satisfaction.
Typical investment menu
Most 401(k) plans offer 15 to 30 investment options across several categories: US large-cap stock index funds, US small/mid-cap stock funds, international stock funds, bond funds (aggregate bond index, government bonds, corporate bonds), target-date retirement funds (automatically adjust allocation based on expected retirement year), stable value or money market funds (capital preservation), and sometimes a self-directed brokerage window for experienced investors. Target-date funds have become the default investment option for most plans. They're designed to be a "set it and forget it" option that automatically shifts from aggressive (stocks) to conservative (bonds) as the target retirement year approaches.
Fee transparency and management
Investment fees directly reduce returns. A 1% annual fee difference over a 30-year career can reduce the final account balance by 25% or more. The Department of Labor requires annual fee disclosure to plan participants. HR teams should work with their plan advisor to ensure the investment lineup includes low-cost index funds. The average expense ratio for 401(k) investments has declined from 0.77% in 2000 to 0.36% in 2023 (ICI, 2024) as employers have shifted toward index funds and fee-conscious plan design. Plan administration fees (recordkeeping, compliance, audit) are separate from investment fees and can be charged to the plan (reducing all participants' balances) or paid directly by the employer.
SECURE 2.0 Act Changes (2022-2027)
The SECURE 2.0 Act of 2022 introduced over 90 provisions affecting 401(k) plans, phased in over several years. These are the changes HR teams need to know.
Auto-enrollment mandate (2025)
New 401(k) plans established after December 29, 2022 must auto-enroll employees at a contribution rate of at least 3% (but no more than 10%), with automatic annual escalation of 1% per year up to at least 10% (but no more than 15%). Existing plans are grandfathered. Small businesses (10 or fewer employees), new businesses (less than 3 years old), church plans, and government plans are exempt. This is the biggest structural change to 401(k) plans in decades and is expected to significantly increase participation rates.
Enhanced catch-up contributions (2025)
For employees aged 60 to 63, the catch-up contribution limit increases to the greater of $10,000 or 150% of the regular catch-up limit ($11,250 in 2025). This "super catch-up" is designed to help people in their peak earning years make up for earlier periods of lower savings. Starting in 2026, catch-up contributions for employees earning over $145,000 must be made as Roth (after-tax) contributions. This change was originally set for 2024 but was delayed.
Student loan matching (2024)
Employers can now treat an employee's student loan payments as if they were 401(k) contributions for the purpose of matching. If an employee makes $500/month in student loan payments instead of contributing to their 401(k), the employer can still deposit the matching contribution into the 401(k). This helps younger employees with student debt start building retirement savings even when they can't contribute directly to the plan.
Emergency savings accounts (2024)
Employers can offer Roth emergency savings accounts linked to the 401(k) plan. Participants can contribute up to $2,500 to this sidecar account, with the first 4 withdrawals per year being penalty-free. Contributions beyond $2,500 are redirected to the Roth 401(k). This feature addresses the criticism that 401(k) plans lock up money that workers may need for emergencies.
Employer Fiduciary Responsibilities
Sponsoring a 401(k) plan creates fiduciary obligations under ERISA. Breaching these duties can result in personal liability for the individuals responsible.
Key fiduciary duties
Acting solely in the interest of plan participants and their beneficiaries. Paying only reasonable plan expenses. Following the plan document. Diversifying plan investments. Selecting and monitoring service providers (recordkeepers, investment managers, advisors). Fiduciary responsibility can't be fully outsourced. Even when using a 3(38) investment manager (who has discretionary authority over investments), the employer retains the duty to select and monitor that manager. Recent lawsuits have held employers liable for excessive recordkeeping fees, underperforming investment options, and failing to regularly benchmark plan costs.
Common compliance mistakes
Late deposit of employee contributions (the DOL requires contributions to be deposited as soon as administratively feasible, which is generally 1 to 3 business days after payroll). Failing to update plan documents when laws change. Not performing required non-discrimination testing (ADP/ACP for traditional plans). Missing Form 5500 filing deadlines. Not distributing required participant notices (summary plan description, fee disclosure, safe harbor notice). Excluding eligible employees from the plan. These mistakes can result in DOL penalties, IRS disqualification, and lawsuits. Most are preventable with good plan administration processes and an attentive TPA (third-party administrator).
401(k) Plan Benchmarking
HR teams should regularly benchmark their 401(k) plan against industry standards to ensure competitiveness and fiduciary compliance.
What to benchmark
Compare your plan's participation rate, average deferral rate, employer match formula, investment menu size and quality, total plan fees (investment plus administrative), and loan/hardship withdrawal rates against industry benchmarks. Vanguard's annual "How America Saves" report and the Plan Sponsor Council of America's (PSCA) annual survey are the two best free benchmarking resources. If your participation rate is below 75%, consider auto-enrollment. If your average deferral rate is below 6%, consider auto-escalation. If your total plan fees exceed 1%, conduct a fee benchmarking study.
Frequently Asked Questions
What happens to a 401(k) when an employee leaves?
Can employees borrow from their 401(k)?
Is the employer required to offer a 401(k)?
What's the difference between a 401(k) and an IRA?
Should a startup offer a 401(k)?
Written by Adithyan RK