401(k)

Definition

A 401(k) is a workplace retirement account where you contribute money from your paycheck before taxes. Many employers offer a match, meaning they add money to your account based on what you contribute. Your contributions and earnings grow tax-free until retirement. You can't withdraw before age 59 1/2 without penalties, except in emergencies. The contribution limit is currently $23,500 annually.

Why it matters

A 401(k) is often the fastest path to building wealth because of employer matching. If your employer matches 50% of contributions up to 6% of salary, that's free money. Someone earning $70,000 contributing 6% ($4,200 annually) gets a $2,100 match. That's a guaranteed 50% return on your money. Employer match is the easiest money you'll ever make. Not capturing it is leaving thousands per year on the table. The tax deferral also reduces your current taxes while letting investments compound tax-free through compounding.

Quick example

You earn $70,000 and your employer matches 50% of contributions up to 6% of salary. Contribute $4,200 annually (6%), and your employer adds $2,100. You've just gotten $2,100 for free. Over 35 years at 8% average returns, that $2,100 annual match grows to about $770,000. Skipping the match is skipping your retirement by years. Compare with a Roth IRA, which doesn't offer matching but provides more flexibility.

The bottom line

Knowing what 401(k) means helps you make better day-to-day money decisions. It makes rates, account options, and tradeoffs easier to compare.