If you’ve ever looked at your paycheck and seen “401(k)” listed, you might’ve wondered: What is this? And why is my money going there? Here is all you want to know about 401(k).
A 401(k) is a retirement savings plan offered by your employer that lets you save aside a portion of your income before taxes are taken out. This reduces your current taxable income, meaning you pay less in taxes now, as well as building your retirement savings for the future. In simple terms, it’s like a smart piggy bank that not only helps you prepare for retirement but also gives you a tax break along the way, giving you dual benefits.
A 401(k) is known as a payroll deduction because the money is automatically taken out of your paycheck before it even reaches your hands. You don’t need to take any action each month, it’s a hands-free savings method that quietly grows your retirement fund over time. For example, if you earn $4,000 a month and contribute $400 to your 401(k), you’re only taxed on $3,600, not the full $4,000. This setup reduces your taxable income now while helping you save for the future.
An added benefit is what’s known as the employer match. Many companies will match your contributions up to a certain percentage, essentially giving you free money toward your retirement. For instance, if you contribute $200 per month and your employer matches that same amount, your monthly retirement savings instantly doubles to $400. It’s one of the easiest and most beneficial ways to boost your long-term savings without extra effort.
According to IRS Notice 2024-80, the elective deferral limit for employees participating in 401(k), 403(b), most 457 plans, and the federal Thrift Savings Plan will increase to $23,500 in 2025, up from $23,000 in 2024. The catch-up contribution limit for employees aged 50 and over remains unchanged at $7,500, allowing a total deferral of up to $31,000 for those eligible.
Additionally, a new provision introduces a “special catch-up contribution” for participants aged 60 to 63, which allows an additional contribution of up to $11,250 in 2025, provided the plan supports it. This is intended to give individuals closer to retirement age an extra boost in their savings capacity.
Lastly, the total defined contribution plan limit, which includes both employee and employer contributions has increased from $69,000 to $70,000 for 2025.
You can begin withdrawing from your 401(k) without the 10% early withdrawal penalty once you reach age 59 1⁄2, provided your plan permits it.
If you withdraw funds before age 59 ½, the IRS generally imposes a 10% additional tax, on top of your ordinary income tax, unless you qualify for a specific exception, such as disability, death, IRS levy, substantially equal periodic payments, hardship reasons, or separation from service after age 55.
And yes, hardship or disability withdrawals made before age 59 ½ can sometimes avoid the penalty, but you must meet the IRS's strict qualifying criteria
When it comes to saving for retirement through your 401(k), you typically have two main options: Traditional (Pre-Tax) and Roth. Both types allow you to invest toward your future, but they differ in how and when you pay taxes.
With a traditional 401(k), your contributions come before taxes are applied to your paycheck. This reduces your taxable income now, which lowers what you owe in income taxes each year. However, when you retire and begin taking withdrawals, those distributions will be taxed as regular income.
Roth contributions work in the opposite way. The money goes in after taxes are taken from your paycheck, which means you don’t get an immediate tax break. But the big benefit comes later, qualified withdrawals in retirement are tax-free, including your investment earnings.
If your employer’s plan allows, you can split your contributions between both traditional and Roth 401(k) accounts. This gives you tax flexibility in retirement. Contribution Limits apply to both.
A Starter 401(k) is a simplified retirement savings plan designed especially for small businesses that don’t currently offer a retirement plan. Unlike traditional 401(k) plans, a starter 401(k) requires less administrative work and has lower costs, making it easier for small employers to implement. Employees are automatically enrolled (unless they opt out), and contributions are made through payroll deductions, just like a regular 401(k). There are no employer matching contributions in this plan, which keeps it simple and affordable for the business owner.
A 401(k) isn’t just a savings plan, it’s a smart strategy for reducing taxes and building long-term financial security together. By contributing regularly, taking advantage of employer matches, and understanding the difference between traditional and Roth options, you can set yourself up for a more stable retirement. With increased contribution limits in 2025 and special catch-up options for those nearing retirement, now is the time to plan wisely. The earlier you start and the more consistent you are, the more your savings can grow over time. Thanks to compounding and tax advantages, make the most of your 401(k) and invest in your future today.
© Copyright PAYPRONEXT. 2025, All Rights Reserved.
