What Is a 401(k) Plan and How Does It Work?
Key takeaways
- A 401(k) plan is an employer-sponsored retirement savings plan with traditional (pre-tax) or Roth (after-tax) contribution options.
- For 2026, employees can defer up to $24,500, plus an $8,000 catch-up starting at 50 years old.
- Matching contributions from your employer can meaningfully boost savings, but many plans use a vesting schedule that ties the match to how long you stay.
- Early withdrawals before age 59½ generally trigger a tax penalty, with limited exceptions.
- Review your contribution election yearly: limits, raises, and catch-up eligibility can all change what you're actually saving.
Hardship withdrawals and loans
Some plans allow hardship withdrawals for an immediate and heavy financial need. Hardship withdrawals are generally taxable and may still be subject to the 10% penalty, unless another exception applies.
Some plans may also allow loans, which let you borrow from your account and repay the money over time. Unlike a withdrawal, a 401(k) loan generally isn't taxable if it follows plan rules and is repaid on time. However, not all plans allow loans, and unpaid loan amounts may be treated as taxable distributions.
Before taking a 401(k) withdrawal or loan, review your plan rules and consider the potential tax consequences and impact on your retirement savings.
Accessing your 401(k) funds during retirement
Once you reach retirement age, your 401(k) shifts from a savings account to an income source—and you have decisions to make about how to access the money.
Withdrawal options
Most plans give you several ways to take distributions once you've separated from your employer at or after 59½. Common options include taking periodic distributions on a schedule, taking lump-sum distributions as needed, or, in some plans, converting your balance to an annuity that pays a set amount over time. You can also leave the money in your former employer's plan if permitted, or roll your 401(k) into an IRA for more investment flexibility and simpler distribution management. The right choice depends on your income needs, the investment choices in your current plan, and how you want to coordinate with other retirement income sources.
Required minimum distributions
In general, once you reach age 73 (or 75, if you were born in 1960 or later), you must begin taking required minimum distributions (RMDs) from all tax-deferred retirement accounts, including 401(k)s. Generally speaking, you can calculate your RMDs for a given year by taking your 401(k) account balance on December 31st of the prior year and dividing it by your "distribution period"—a number the IRS assigns to each age.
For example, let's say you're 75, single, and ended last year with $1 million in your 401(k). According to the IRS, your distribution period is 24.6—which means your RMD for the year would be $40,650 ($1,000,000 ÷ 24.6).
If you have multiple tax-deferred retirement accounts, RMDs must be calculated separately for each one. Many financial institutions, including Schwab, will help calculate your RMDs for you—and may even offer automated withdrawals—but typically only for the accounts held at their firms.
Coordinating with other accounts
Most retirees draw income from more than one source: a 401(k) or IRA, taxable brokerage accounts, Roth accounts, and Social Security. The order in which you tap each can affect your lifetime tax bill, since traditional 401(k) withdrawals count as ordinary income while Roth withdrawals generally don't. A common retirement withdrawal strategy is to draw from taxable accounts first, then tax-deferred accounts, then Roth—but the right sequence depends on your tax bracket, your RMD obligations, and your other income. Consider working with a tax professional or financial advisor to map out a withdrawal strategy that fits your situation.
401(k) FAQ
Why is it called a 401(k) plan?
A 401(k) gets its name from the U.S. tax code. It refers to Section 401(k) of the Internal Revenue Code, the law that created and governs this type of retirement plan.
How should I prioritize my 401(k) alongside other financial goals?
A 401(k) is one piece of a broader financial picture that may also include paying down debt, building an emergency fund, saving for a home, or funding a child's education. For most workers, contributing at least up to the employer match is a strong starting point, since it captures the full benefit your plan offers. From there, how you balance additional 401(k) contributions against other goals depends on your timeline, your tax bracket, and which debts or savings gaps are most pressing. For a framework on sequencing these decisions, check out our guide to saving for multiple financial goals.
" id="body_disclosure--media_disclosure--261851" >A 401(k) is one piece of a broader financial picture that may also include paying down debt, building an emergency fund, saving for a home, or funding a child's education. For most workers, contributing at least up to the employer match is a strong starting point, since it captures the full benefit your plan offers. From there, how you balance additional 401(k) contributions against other goals depends on your timeline, your tax bracket, and which debts or savings gaps are most pressing. For a framework on sequencing these decisions, check out our guide to saving for multiple financial goals.
When is the deadline to contribute to my 401(k) plan?
401(k) contributions must be made through payroll during the calendar year—unlike IRAs, you can't contribute for the prior year after December 31. It's worth reviewing your contribution election at least once a year to make sure you're putting away what you intended.
How are 401(k) funds invested?
Generally, you can choose from a range of investments to fit your risk tolerance and time to retirement. Each 401(k) plan tends to offer different investment choices, including mutual funds, exchange-traded funds (ETFs), target-date funds, index funds, money market funds, and individual stocks and bonds. You may also have the option to choose a self-directed account or have your account managed for you.
What happens to my 401(k) if I change jobs?
There are several ways to handle a 401(k) when leaving a job, including leaving your money in the old 401(k), rolling it into your new employer’s 401(k) plan, rolling it into an individual retirement account (IRA), or converting it to a Roth IRA. You can also cash out, but if you are younger than 59½, cashing out triggers early withdrawal penalties, 20% federal tax withholding, and potentially state taxes, as well.
" id="body_disclosure--media_disclosure--261846" >There are several ways to handle a 401(k) when leaving a job, including leaving your money in the old 401(k), rolling it into your new employer’s 401(k) plan, rolling it into an individual retirement account (IRA), or converting it to a Roth IRA. You can also cash out, but if you are younger than 59½, cashing out triggers early withdrawal penalties, 20% federal tax withholding, and potentially state taxes, as well.
Can I contribute to both a 401(k) and IRA?
It's possible to contribute to both an IRA and a 401(k). However, if the IRS considers you to be covered by a 401(k) plan at work, your IRA tax deduction may be limited or phased out. But this would not affect your annual 401(k) contribution or IRA contribution limit. To learn more about IRA deduction rules, see IRS Publication 590-A.
" id="body_disclosure--media_disclosure--261916" >It's possible to contribute to both an IRA and a 401(k). However, if the IRS considers you to be covered by a 401(k) plan at work, your IRA tax deduction may be limited or phased out. But this would not affect your annual 401(k) contribution or IRA contribution limit. To learn more about IRA deduction rules, see IRS Publication 590-A.