401(k)

A 401(k) is an employer-sponsored retirement savings plan in the United States, named after Section 401(k) of the Internal Revenue Code. It allows employees to contribute a portion of their pre-tax salary to a retirement account, where investments grow tax-deferred — meaning no tax is paid on contributions or growth until money is withdrawn in retirement.

The 401(k) is the primary private retirement savings vehicle for US workers, complementing Social Security. Most plans offer a menu of mutual funds (often index funds) to invest in. A key feature of many 401(k) plans is the employer match, where the employer contributes additional funds based on the employee's contribution — effectively providing an immediate return on savings.

The Indian equivalents are EPF (mandatory, fixed return), NPS (voluntary, market-linked), and PPF (individual, fixed return).

Future Value of 401(k) = FV of annuity of contributions + FV of employer matches

For regular monthly contributions:

FV = C × [(1 + r)^n − 1] / r

Where:

• C = Monthly contribution (employee + employer match)
• r = Monthly return = Annual expected return ÷ 12 ÷ 100
• n = Number of months

You earn $80,000/year and contribute 6% ($4,800/year = $400/month). Your employer matches 100% on the first 6% ($400/month). Total monthly contribution = $800. Over 30 years at an assumed 7% annual return:

• FV = $800 × [(1 + 0.005833)^360 − 1] / 0.005833 ≈ $972,000

Your out-of-pocket contribution: $144,000. The employer match contributed another $144,000. Growth added over $680,000. Try the 401(k) calculator for your specific scenario.

• Always capture the full employer match first: It is a 50–100% immediate return on your contribution. No other investment offers that.
• Tax-deferred compounding: Because no tax is deducted until withdrawal, your full investment compounds. This is particularly valuable over long time horizons — a 30-year compounding window is transformative.
• Contribution limits matter: The $23,500 limit (2025) is per person, per year. If you have side income or a second job, you share one limit across all 401(k)s.
• Vesting schedule: Employer matches may vest over 3–6 years. If you leave before fully vested, you forfeit unvested employer contributions.
• Early withdrawal penalty: Withdrawing before age 59½ triggers a 10% penalty plus income tax. There are exceptions for disability, certain medical expenses, and substantially equal periodic payments (SEPP / Rule 72(t)).
• Required Minimum Distributions (RMDs): Starting at age 73, you must withdraw a minimum amount annually calculated from your balance and life expectancy. Roth 401(k)s are also subject to RMDs (unlike Roth IRAs).
• S-corp strategy for self-employed: Self-employed individuals can set up a Solo 401(k), contributing both as employee ($23,500) and employer (up to 25% of net SE income), significantly exceeding the individual limit.