UNDERSTANDING 401K PLANS

Planning for retirement can feel overwhelming, especially with so many options available. One of the most popular vehicles for retirement savings is the 401k plan. You may have one through your employer, but do you know how it works and how to make sure it will meet your retirement income needs? Gaining a clearer understanding of how to effectively use a 401k as part of your retirement strategy can help you make informed decisions that align with your long-term financial goals.

Comparing Retirement Vehicles

When it comes to saving for retirement, understanding the different types of retirement accounts available is crucial. Each vehicle has its unique features, benefits and limitations, which can significantly impact your savings strategy. Let’s take a look at your options and how a 401k compares to each of them.

401k vs. IRA

When considering your retirement planning options, many individuals turn first to 401k plans and Individual Retirement Arrangements as their primary retirement savings vehicles due to their tax advantages and potential for long-term growth. Both options are widely recognized for their ability to help investors accumulate funds for retirement while providing various tax benefits.

A 401k plan, typically offered by employers, enables employees to save through payroll deductions, often accompanied by employer matching contributions. Meanwhile, IRAs provide a flexible savings alternative that is accessible to anyone with earned income. Together, these accounts form the cornerstone of many investors’ retirement strategies, offering a structured way to save while taking advantage of tax incentives.

When individual investors consider choosing between a 401k and an IRA, they typically weigh some of the following factors:

• Contribution limits: One of the primary differences between a 401k and an IRA is the contribution limit. In 2025, you can contribute up to $23,500 to a 401k plan (up from $23,000 in 2024), with an additional $7,500 catch-up contribution allowed for those aged 50 or older. This allows individuals who are nearing retirement to significantly boost their savings, which is especially important if they feel behind in their retirement planning. In contrast, the contribution limit for an IRA is $7,000, with a $1,000 catch-up contribution for individuals aged 50 and older. This significant difference in contribution limits means that a 401k may allow you to save more aggressively for retirement, particularly if you’re starting later in life or looking to maximize your savings in your peak earning years.
• Tax treatment: Contributions to a traditional 401k are made with pre-tax dollars, which reduces your taxable income for the year and can lead to significant tax savings. This means you won’t pay taxes on the money until you withdraw it in retirement, when you’re potentially in a lower tax bracket. Contributions to a traditional IRA may or may not be tax-deductible, depending on your income and other factors.
• Employer matching: Another critical advantage of 401k plans is the employer match feature. Many employers offer to match employee contributions up to a certain percentage, essentially providing “free” money for your retirement savings. In contrast, most IRAs do not typically offer this feature, making the 401k a more appealing option for many employees. If your employer offers matching, it’s essential to contribute at least enough to fully capture this benefit and optimize your savings strategy.

401k vs. Roth IRA

While both Roth IRAs and 401k plans help you save for retirement, they serve different purposes and cater to different financial strategies and priorities:

• Tax treatment: Roth IRAs provide tax-free growth and tax-free withdrawals in retirement, making them particularly advantageous if you expect to be in a higher tax bracket in retirement. In contrast, 401k plans are taxed upon withdrawal, which can impact your retirement income depending on your tax situation.
• Flexibility: Roth IRAs offer greater flexibility regarding withdrawals. You can withdraw contributions at any time without penalties, which can be beneficial if you encounter financial emergencies. This can provide a safety net for younger savers or those who may need access to their funds before retirement. In contrast, 401k withdrawals before age 59½ generally incur penalties and taxes, although there are exceptions for hardship withdrawals.

These differences may influence your decision on which account to prioritize based on your current and expected future tax rates and flexibility needs. If you anticipate being in a higher tax bracket during retirement or want greater withdrawal flexibility, a Roth IRA may be more advantageous, whereas if you expect to be in a lower tax bracket and don’t anticipate tapping your 401k until after at least after age 59½, a traditional 401k may be better suited to your needs.

Traditional 401k vs. Roth 401k

If you’re torn between a traditional 401k and a Roth IRA, you might want to consider a Roth 401k, which features some of the benefits and limitations of each.

• Tax treatment: In contrast to a traditional 401k, a Roth 401k involves after-tax contributions, meaning you don’t get an immediate tax break. The advantage here is that withdrawals in retirement are tax-free, including any investment gains, assuming you meet certain age and holding period requirements. This option can be ideal if you expect to be in a higher tax bracket later, want tax-free income streams in retirement, or prefer tax certainty for long-term planning.
• Contributions: Roth 401k accounts have the same annual contribution limits as a traditional 401k, as set by the IRS. However, when it comes to employer matching, you should be aware that any employer match will always be made on a pre-tax basis and placed in a traditional 401k, even if your contributions are Roth.
• Withdrawals: Withdrawals before age 59½ can incur penalties in both types of accounts, though the Roth 401k allows for tax-free withdrawals of contributions (not earnings) if certain conditions are met, adding some flexibility.

Another option is to diversify between the two types of accounts by contributing to both, which can provide tax flexibility in the future and allow you to optimize withdrawals based on changing tax landscapes.

401k vs. 403(b)

403(b) plans are similar to 401k plans but are designed specifically for employees of non-profit organizations, schools and certain government entities.

• Contributions: The contribution limits for 403(b) plans align with those of 401k plans, allowing contributions of up to $23,500, plus catch-up contributions for those aged 50 and older. This similarity allows employees in non-profit sectors to take advantage of the same savings potential as those in for-profit sectors.
• Investment flexibility: 403(b) plans often have fewer investment choices, typically limited to annuities and mutual funds. This can restrict growth potential compared to 401k plans, which may offer a broader range of investment options, including individual stocks and various types of funds.

401k Contributions: What to Do Before Retirement

If you have chosen a 401k, it’s important to know how to contribute effectively so you can make every effort to maximize your retirement savings.

Again, the contribution limit for a 401k in 2025 is $23,500, with a catch-up contribution of $7,500 for those aged 50 and older. Ideally, that is your contribution goal. Maxing out your contributions can significantly enhance your retirement savings, allowing your money the opportunity grow more effectively over time due to the power of compounding.

Employer Matching Contributions

To fully capitalize on your 401k, take advantage of your employer’s matching contributions. If your employer matches up to a certain percentage of your contributions, aim to contribute at least that amount to avoid leaving “free” money on the table. For example, if your salary is $50,000 and your employer matches 50% of your contributions up to 6%, you should contribute at least $3,000 to receive the full match, effectively adding $1,500 to your retirement savings.

It's also wise to periodically review your employer’s matching policy, as some companies change their contribution strategies or caps. Ensuring you are on track to take full advantage of the match can be a straightforward way to boost your retirement savings without any additional effort.

When you leave an employer to start a new job, there are several options for what to do with your 401k—including leaving it where it is, rolling it over into a new 401k or IRA or cashing it out. Be sure to evaluate the options carefully to choose the right one for your circumstances.

Understanding 401k Fees

Fees can significantly impact your retirement savings, so it’s important to understand the costs associated with your 401k plan. Common fees include:

• Administrative fees: These are costs associated with managing the plan, which can vary widely among different plans. They may cover record-keeping and customer service expenses. Always review your plan’s fee disclosure statement to understand what fees you are being charged and why.
• Investment fees: These are fees charged by the funds you invest in, often expressed as an expense ratio. Lower expense ratios can lead to higher returns over time, so be sure to compare these fees across the investment options in your plan. For instance, even a small difference in fees—say 0.5%—can result in tens of thousands of dollars less in retirement savings over several decades.
• Transaction fees: These charges may apply to certain transactions, such as fund transfers or loans. Understanding these fees can help you make informed decisions about managing your investments. If your plan has high transaction fees, it may be worth considering other investment options or plans.

To gain a better understanding of the fees, review your plan’s fee disclosure statement. Consider consulting with a financial advisor to understand which fees are reasonable and which may be excessive. They can help you identify appropriate investment options and strategies for helping minimize fees.

Other costs and tax implications can come into play if you’ve inherited a 401k plan from a parent or spouse, so be sure you understand those details before you make any decisions about how to receive the inherited 401k plan.

Hardship Withdrawals

Avenues to accessing funds from your 401k plan prior to retirement are limited. If you have an immediate and heavy financial need, you may qualify for a hardship withdrawal. Hardship reasons can include medical expenses, tuition payments, funeral expenses, payments to avoid eviction or foreclosure, down payment for the purchase of a primary residence or expenses to repair damage to a primary residence. However, hardship withdrawals may still be subject to taxes and penalties if you are under the age of 59.5.

Before pursuing this option, it’s important to understand the specific criteria for hardship withdrawals because each plan may have different rules. First, consider if there are other financial resources available to you, as tapping into your retirement savings can have long-term implications for your financial security.

Borrowing Against Your 401k

Many plans allow participants to borrow against their 401k. While this can be a quick way to access cash, the cons typically outweigh the pros, so we don’t generally recommend it.

• Pros: It allows quick access to funds with no credit check required, which can be advantageous for those with less-than-perfect credit histories. This option may provide financial relief in emergencies without affecting your credit score. Additionally, interest rates on 401k loans may be lower than those on personal loans, making it a more cost-effective option.
• Cons: Borrowing from your retirement savings can significantly reduce the amount available for your future needs. You must repay the loan with interest, usually within five years. Additionally, if you leave your job before fully repaying the loan, the outstanding balance may be considered a distribution, triggering taxes and penalties. This could jeopardize your retirement savings and create a tax liability. Lastly, if the loan becomes a distribution, you’ll lose out on any compounding that would have accumulated on the borrowed amount over the period of time that passes until you repay the loan.

If you find yourself considering a 401k loan, evaluate your current financial situation carefully and consult with a financial advisor before taking action. Exploring other options for short-term financing, such as personal loans or lines of credit, may be better for your personal situation than tapping into your retirement funds.

Preparing for Retirement

There are many things you’ll spend time thinking about and planning for in the years and, eventually, months before retirement. Along with planning and strategizing for what you’ll do, where you’ll live and what your life will look like in retirement, be sure you’re putting time and thought into the important financial milestones you need to hit to enable your transition into and through retirement. Before it comes time to retire, consider the following steps to help ensure a smooth transition into retirement:

• Review your investment allocation: As you approach retirement, it’s important that your investments align with your risk tolerance and time horizon. Generally, you may want to gradually shift from more aggressive investments to more conservative options so you can reduce risk. This focus on asset allocation can help protect your savings as you near retirement.
• Decide your work status: If you’re thinking about continuing to work and possibly pursuing a phased retirement, consult a financial advisor to learn how that may impact your income, retirement plan withdrawals and more.
• Create a retirement budget: Understanding your expected expenses in retirement will help you gauge how much you need to save. This budget should account for daily living expenses, healthcare costs, travel plans and any debt obligations. Additionally, consider potential fluctuations in your expenses over time, as healthcare costs may rise, and lifestyle changes could impact your spending.
• Consult a financial advisor: A professional can tailor a plan to help meet your retirement goals. They can offer insights into market conditions, tax implications and investment strategies that align with your objectives, helping ensure you’re well-prepared for retirement. Meeting with a financial advisor can also provide peace of mind, as they can help clarify complex financial concepts and assist you in making informed decisions.

401k Withdrawals: What to Do After Retirement

Once you retire, it’s time for all that thoughtful planning to pay off. Now you can activate the plan for accessing your 401k funds that can help sustain your lifestyle through retirement.

Regular Withdrawals

Once you reach age 59½, you can start taking distributions from your 401k without incurring penalties. However, keep in mind that ordinary income taxes will apply to these distributions. It’s important to plan your withdrawals strategically to manage your overall tax burden in retirement. For instance, you might consider withdrawing from your 401k in years when you have lower income to minimize your tax bracket.

Additionally, consider your overall withdrawal strategy—some retirees opt for a combination of 401k withdrawals, Social Security benefits and other income sources to create a more balanced and tax-efficient income stream. A financial advisor and tax professional can help you develop a withdrawal strategy that meets your needs while minimizing taxes.

Mastering 401k Fundamentals

Understanding 401k plans is a fundamental aspect of effective retirement planning. By familiarizing yourself with the various types of retirement accounts, contribution limits, employer matches, fees, withdrawal options and tax implications, you can create a comprehensive strategy that aligns with your financial goals. A well-structured 401k plan can be a powerful tool for building a secure and comfortable retirement, so take the time to put careful thought and planning into maximizing its potential for you.

By educating yourself and planning ahead, you can take confident steps toward achieving your retirement dreams. So, if you’re navigating the complexities of your 401k or any other retirement accounts, consider reaching out to a financial advisor. They can provide personalized guidance tailored to your specific circumstances and help you make informed decisions that can pave the way for the successful retirement you’ve earned.