How a 401(k) Works—And Why It’s Worth Paying Attention To

A 401(k) is a powerful tool for building your financial future. It’s a retirement savings plan offered through many employers, and it’s designed to help you invest consistently over time. If you’re wondering how a 401(k) works—and why it’s worth paying attention to—this guide will walk you through the basics in practical, beginner-friendly terms.

Whether you’re just starting your first full-time job or simply haven’t looked into your benefits yet, now is a great time to understand what this plan can do for you.

✅ How a 401(k) Works

1. You save automatically
   Once you’re enrolled, a portion of your paycheck is sent directly to your 401(k).  You may be auto-enrolled by your employer for some small percentage as a default. This happens before you even see the money—making it an easy and consistent way to save.
2. You get a tax benefit
   Your contributions are deducted before taxes are taken out, which reduces your taxable income for the year. For example, if you contribute $100 and are in the 15% tax bracket, your paycheck might only feel $85 smaller. This means you’re saving more and paying less tax now.
3. Some employers contribute, too
   Many employers offer a matching contribution. This means they’ll add money to your 401(k) when you do, up to a certain amount. If that’s available to you, try to contribute enough to get the full match—it’s a valuable benefit designed to help you save more for retirement.
4. Your savings grow over time
   The money in your 401(k) is invested in options like mutual funds, stocks, exchange traded funds or bonds. Over time, these investments can grow, helping your savings keep pace with inflation and possibly even outpace it.
5. It’s built for the long term
   This account is meant for retirement, so withdrawing funds before age 59½ may come with penalties and taxes. Think of it as a way to take care of your future needs, not today’s expenses.

📊 401(k) Contribution Limits for 2025

• Under age 50: $23,500
• Ages 50–59: $31,000
• Ages 60–63: $34,500

Even small contributions matter. You don’t need to hit the maximum—what’s more important is starting and staying consistent.

🌱 Why Starting Now Matters

The earlier you begin contributing to your 401(k), the more time your money has to grow. This growth happens through compounding—where the money you invest earns returns, and those returns start earning more returns.  I didn’t understand this when I first started out and I left valuable years of compounding behind, which meant I needed to work harder later to save more to try to catch up.

Starting early, even with a small amount, can make a big difference over time.

💡 Quick Tip

If your company offers matching contributions, aim to contribute at least enough to receive the full match. That’s money added to your savings simply because you participated.

Looking Ahead: Roth 401(k) Options

Some employers also offer Roth 401(k) plans, which have different tax benefits. In short, you pay taxes now and enjoy tax-free withdrawals later. We’ll break this down in an upcoming post.

📌 Action Step: Review Your 401(k) Options

Take 10 minutes today to review your company’s benefits guide or visit your HR portal. If you haven’t signed up for your 401(k) yet—or aren’t sure if you’re getting your full match—this is the time to check.

Saving for the future isn’t about doing everything perfectly—it’s about starting where you are and building from there.

For more information on types of retirement plans- refer to this link for the Department of Labor Website: https://www.dol.gov/general/topic/retirement/typesofplans