The account looks simple. The decisions around it aren't. Traditional or Roth? How much of the employer match can you keep if you leave? What happens to the balance when you change jobs? Plan documents answer these, but few people read them.
This guide covers how a 401(k) works, the 2026 limits, matching and vesting, investment choices, withdrawals, and what to do with the money when you leave an employer.
Key Takeaways
- A 401(k) moves money from your paycheck into investments, often with employer contributions.
- Traditional and Roth contributions are taxed at different times.
- Matching, vesting, fees, and investment menus shape what you actually keep.
- Withdrawals and rollovers carry taxes and plan-specific rules. Check before moving money.
What Is a 401(k) and How Does It Work?
What a 401(k) plan is
A 401(k) is a defined-contribution plan named after Section 401(k) of the Internal Revenue Code. The IRS describes it as an arrangement where employees contribute wages to individual accounts, and employers may add money too.
Eligibility comes from the plan document. Plans generally can require age 21 and one year of service, though many are more generous. Some plans enroll you automatically. Under SECURE 2.0, most new plans must start employees at a default of 3% to 10% and raise it by one percentage point a year.
Not every worker has a 401(k). Other options include:
- 403(b) plans for schools and nonprofits
- 457(b) plans for government employees
- SEP IRAs and SIMPLE IRAs for small businesses
- Solo 401(k)s for self-employed owners
How money moves through the plan
The flow is straightforward:
- You elect a percentage or dollar amount.
- Payroll deducts it from each paycheck.
- The plan recordkeeper credits your account.
- Your money goes into the investments you select, or a default fund.
- You receive account statements, generally at least quarterly.
Your balance changes with your contributions, employer contributions, investment gains or losses, fees, and distributions.
What to review in your plan
Gather these documents:
- Summary plan description
- Fee disclosures
- Investment menu
- Vesting schedule
- Beneficiary form
- Online login instructions
A 401(k) is an investment account, not a guaranteed savings account. Your future balance depends partly on what you choose and how markets perform.
Traditional vs. Roth 401(k)
The difference is when you pay tax.
| Feature | Traditional | Roth |
|---|---|---|
| Contributions | Pre-tax, reducing current taxable income | After-tax |
| Withdrawals | Generally taxable | Qualified withdrawals tax-free |
| Qualification | Not applicable | Five-year period plus age 59½, disability, or death |
| Lifetime RMDs | Yes, when required | None since 2024 |
If your plan offers Roth, you can split contributions between the two in any proportion. One combined limit applies, and no income ceiling blocks Roth 401(k) deferrals.
Neither option wins universally. Weigh these factors:
- Current tax bracket vs. expected retirement bracket
- When you plan to retire
- Other income sources in retirement
- Whether holding both types gives you withdrawal flexibility
SECURE 2.0 also lets plans offer Roth employer matching, which must be fully vested and is taxable in the year it's allocated.
How Contributions, Employer Matching, Vesting, and Investments Work
Employee contributions and 2026 limits
You choose a percentage or amount through payroll. The IRS sets the ceilings in Notice 2025-67:
- $24,500 employee deferral limit (traditional and Roth combined)
- $8,000 catch-up for age 50 and over, if the plan allows
- $11,250 catch-up for ages 60 to 63
- $72,000 total annual additions, or 100% of pay if lower, counting employer money
Starting in 2026, higher earners (more than $150,000 in prior-year wages from that employer) must make catch-up contributions as Roth. The test uses 2025 wages.
If you exceed the limit, the excess generally must be returned by April 15 of the next year, or it can be taxed twice.
Capturing the employer match
Matching formulas vary. Here is a hypothetical: an employer matches 50% of your contributions up to 6% of pay. If you earn $80,000 and contribute 6% ($4,800), the employer adds $2,400. Contribute 3% and you leave $1,200 on the table.
Not every employer matches. According to the PSCA's 68th survey, 81.3% of surveyed plans offered some match, with an average maximum match of 4.7%. Read your formula and, if your budget allows, contribute enough to capture all of it.
Understanding vesting
Your own contributions and their earnings are always 100% yours. Employer money may follow a schedule:
- Cliff vesting: fully vested after up to three years
- Graded vesting: gradually vested, fully after up to six years
Faster schedules are allowed. The PSCA survey found 44.1% of plans with a match vest it immediately. Check your schedule before changing jobs, since unvested employer money stays behind.
Choosing investments
Typical menus include target-date funds, index funds, other mutual funds, stable-value options, and bond or stock funds. Target-date funds are offered by 85% of surveyed plans.
When reviewing choices, weigh:
- Years until you need the money
- Your tolerance for losses
- Diversification across asset types
- Fund expenses
- Your other accounts
Fees matter more than most people expect. A Department of Labor example shows $25,000 growing over 35 years at 7% to roughly $227,000 with 0.5% fees but $163,000 with 1.5% fees. It's an illustration, not a forecast.
Avoiding set-it-and-forget-it
Revisit your plan after raises, job changes, and each year's limit update. Check beneficiaries, fees, allocation, and match eligibility.
Common mistakes:
- Missing the full match
- Ignoring fees
- Leaving an old beneficiary in place
- Taking too much or too little investment risk
- Exceeding contribution limits
- Cashing out after a job change
How Withdrawals, Loans, and RMDs Work
Accessing money before retirement
Taxable distributions before age 59½ generally face an extra 10% tax on top of ordinary income tax, unless an exception applies. An exception removes the penalty, not necessarily the income tax.
Exceptions include:
- Separation from service in or after the year you turn 55
- Death, total disability, or qualifying terminal illness
- Substantially equal periodic payments
- Birth or adoption, up to $5,000
- Emergency personal expenses, generally up to $1,000
- Disaster recovery, up to $22,000
- Medical expenses above 7.5% of adjusted gross income
Loans vs. hardship withdrawals
Both are optional plan features, so confirm your plan offers them.
| Feature | Loan | Hardship withdrawal |
|---|---|---|
| Amount | Lesser of 50% of vested balance or $50,000 | Only what's needed for an immediate and heavy financial need |
| Repayment | Generally within five years | Cannot be repaid or rolled over |
| Tax | None unless you default | Income tax, possibly the 10% penalty |
If you leave your employer with an unpaid loan, the balance can become a taxable deemed distribution. A loan offset caused by separation can be rolled over by your tax-return due date, including extensions.
Retirement distributions and RMDs
In retirement, you might take scheduled withdrawals, occasional distributions, or roll the money elsewhere. Ordinary income tax and market risk still apply to traditional balances.
Required minimum distributions generally begin at 73, or 75 if you were born in 1960 or later. The first RMD is due by April 1 of the year after you reach that age; later ones are due by December 31 each year.
Missing an RMD triggers a 25% excise tax on the shortfall, reduced to 10% if corrected promptly. Roth 401(k) balances have no lifetime RMDs.
What Happens When You Leave a Job or Retire?
Options for an old 401(k)
You can:
- Leave it in the former employer's plan, if allowed
- Move it to a new employer's plan, if accepted
- Roll it into an IRA
- Cash out
When you choose, compare:
- Fees and investment choices
- Creditor protection and withdrawal flexibility
- Loan availability and ease of consolidating
ERISA plans carry federal protection from creditors, while IRA protection outside bankruptcy varies by state. Plans may also push out small balances: those between $1,000 and $7,000 can be moved to an IRA without your election.
Direct and indirect rollovers
A direct trustee-to-trustee rollover avoids mandatory withholding. With an indirect rollover, the plan generally withholds 20% for federal taxes and you have 60 days to deposit the full amount, including the withheld portion, into the new account.
Don't treat a rollover check as spendable cash. Missing the deadline makes the unrolled amount taxable and possibly subject to the 10% penalty. Direct rollovers are reported on Form 1099-R, usually with Code G.
Planning the transition into retirement
Your 401(k) decision should fit with Social Security, other retirement accounts, taxable savings, spending goals, and beneficiary wishes. The average retired-worker benefit is about $2,089 a month, per SSA.
Lewis & Associates Capital Advisors, LLC is an independent fiduciary advisory firm in North Carolina that helps eligible clients weigh retirement-account and rollover choices within a personalized plan. A rollover to an IRA isn't always the best answer, and leaving money in an employer plan can be the right call.
Frequently Asked Questions
How much do I need in my 401(k) to get $1,000 a month?
It depends on how long you need income, your withdrawal rate, returns, inflation, taxes, and other income. Morningstar's 2025 research gave 3.9% as a starting withdrawal rate for 30 years, which implies roughly $308,000 for $12,000 a year before taxes. Treat it as a rough starting point.
How can I calculate my 401(k) balance?
Check your online portal or latest statement. It shows contributions, employer money, gains or losses, fees, and withdrawals. A projection of future value is a separate estimate, not a guarantee.
What are common 401(k) mistakes to avoid?
Missing the full match, ignoring fees, outdated beneficiaries, mismatched investment risk, exceeding limits, and cashing out at a job change without weighing alternatives.
What happens to a 401(k) when you quit?
You can leave it, move it to a new plan, roll it to an IRA, or take a distribution. Review taxes, vesting, fees, and plan rules first.
Do I get all of my 401(k) when I retire?
Your contributions and vested employer money generally belong to you. Income taxes, investment changes, and plan distribution rules still apply.
What are the new 401(k) withdrawal rules for 2026?
Standard rules still apply: the 10% penalty before 59½ with listed exceptions, plus RMDs at 73 or 75. New for 2026 are Roth catch-up requirements for higher earners. Confirm details with current IRS guidance and your plan documents, since rules can change.
