Guide to 401(k) Plans

The field nobody explained

Three weeks into her first real job, Jordan opens the benefits portal. The onboarding window closes Friday, and one screen has a field she doesn’t recognize: Contribution %, with a box defaulting to 0%. No one has told her what belongs there. She types 3% because it sounds responsible, clicks submit, and moves on.

That single number, the percent of each paycheck routed into her 401(k) before it ever reaches her bank account, is the most consequential money decision of her first year. And almost nobody gets walked through it. Most people contribute the wrong amount, not because they don’t care, but because the choice happens in a ten-minute enrollment window with nobody explaining what the number means. This guide is the walk-through Jordan didn’t get: what the account is, what to type in that box, and what happens to the money after.

What the field decides

What Jordan was looking at is a salary deferral — the defining feature of a 401(k). A 401(k) is an employer-sponsored retirement account, named after the subsection of the U.S. tax code that created it, and “defined contribution” means your eventual balance depends on how much you and your employer put in and what those investments earn. That’s unlike an old-style pension, where the benefit is fixed in advance. The deferral is the lever you control: a portion of your paycheck moves into the account, and in a traditional 401(k) it goes in before income tax is calculated, lowering your taxable income for the year.

Which tax treatment fits your bracket

Jordan’s screen had a second choice next to the percentage: traditional or Roth. One question decides it — do you expect to be in a higher tax bracket now, or in retirement?

Traditional: the tax break comes now

Contributions come out of your paycheck pre-tax, so your taxable income drops in the year you contribute and the money grows tax-deferred. The trade-off arrives later: withdrawals in retirement are taxed as ordinary income — the regular income-tax rates a paycheck pays, not the lower rates on long-term investment gains. That tax is figured at your retirement-year marginal rate, set by retirement income such as Social Security, pension, and required withdrawals, which for many people lands in a lower bracket than their working years. (See mental models for tax thinking for what marginal means in practice.)

Roth: tax-free later

Roth contributions are after-tax — you pay income tax before the money goes in, so it doesn’t lower this year’s taxable income. In exchange, the earnings grow tax-free, and qualified withdrawals in retirement are tax-free too. “Qualified” means after age 59½ and at least five years since your first contribution to this specific Roth 401(k); that five-year clock is per-plan, unlike a Roth IRA where it spans your whole Roth-IRA history. Your own contributions can be Roth, but the employer match is typically made pre-tax and lands on the traditional side of the account, so an all-Roth saver usually still builds some traditional balance.

If your bracket genuinely could go either way, the Roth vs. Traditional guide walks the full decision framework.

The match: free money with a threshold

Here’s what Jordan’s 3% cost her. Many employers match part of what you contribute — a common formula is 50% on the first 6% of your gross pay. Match every dollar up to that 6% and the employer adds 50 cents on top of each; stop at 3%, like Jordan did, and you collect only half the match that was sitting there for you.

The match is free money — once it vests. A typical schedule grants 20% per year of service (“graded”) or 100% after a single threshold like three years (“cliff”); leave before then and the unvested portion returns to the employer.

What “6% of gross” means on a paycheck

When your HR portal asks “what percent do you want to contribute?”, that percentage runs against your gross paycheck — the full amount you earned before taxes, FICA, and any other deductions. It does not run against your take-home pay.

A typical example: you earn $5,000 gross per pay period and elect a 10% deferral. Payroll deducts $500 (10% × gross) into the 401(k), then computes income tax and FICA on the remaining $4,500, then deducts your health insurance premium and anything else, and what’s left lands in your bank as take-home. Your employer match is calculated the same way — against the gross.

This is why the order of operations anchors “15% to retirement” against gross income. Anchoring on take-home would silently undersave by ~30%, since taxes and deductions can eat that much off the top.

If this is your first job and the whole paycheck breakdown still feels opaque, the first-paycheck guide shows where every dollar goes before you set the percentage.

What under-deferring costs over a career

Jordan’s half-match is the version of this you can see today. The compounding version takes decades to show up, and it’s bigger. The waterfall below traces a $680K retirement shortfall between two savers: a 22-year-old who starts at 15% and a 30-year-old who starts at 8%. Four specific levers produce that gap, and every one of them is yours to set.

The two biggest levers are when you start and how much you defer; together they account for 72% of the gap. The other two are smaller but still yours: the employer match, and the fund fees — the expense ratios on your fund choices.

None of this depends on what the market does in any given decade. To run your own numbers, the compound growth calculator lets you change the inputs; the order of operations covers which account to fund first.

2026 contribution limits

The IRS caps how much you can put in each year. These are ceilings — you can always contribute less.

Workers ages 60–63 get an enhanced catch-up up to $11,250 per SECURE 2.0 — a narrow band that doesn’t affect most readers, but worth knowing exists if you’re in it.

What to invest in once the percent is set

Setting the percentage decides how much goes in; it doesn’t decide what the money buys. A 401(k) is just the container, a tax-advantaged wrapper, and you pick the investments from your plan’s menu. For most people the right answer on that menu is a low-cost index fund or a target-date fund — the guide to investment vehicles covers how to tell them apart and why the cheap option usually wins.

When you can touch the money

The flip side of the tax break is that the money is meant to stay put. Pull it out before age 59½ and you generally owe a 10% penalty on top of ordinary income tax, though some hardship exceptions exist; your plan administrator can confirm whether your situation qualifies.

The penalty and the tax are the costs you can see. The bigger one is invisible: the money’s lifetime of compounding, gone for good. A dollar pulled at 30 isn’t a dollar spent — at the market’s long-run average, before inflation, that dollar would have grown to roughly $33 by 65. The penalty stings once; the lost growth follows you for the rest of your career, which is why a retirement account is the last place to reach when cash is tight, not the first. The mental models guide puts numbers on that wealth multiplier.

There’s a softer-looking version of the same temptation: borrowing against the balance instead of withdrawing it. It skips the penalty, but it carries its own hidden costs — lost growth, a tax bomb if you leave or lose the job, even the match if affording the payment means cutting your contributions. The 401(k)-loan Moment walks them before you press that button.

In retirement, traditional withdrawals are taxed as ordinary income while qualified Roth withdrawals come out tax-free. Traditional balances also carry required minimum distributions (RMDs) starting at age 73 — rising to 75 in 2033 under SECURE 2.0, for anyone born in 1960 or later; Roth 401(k)s no longer have them.

When you switch jobs

When you leave a job, the balance doesn’t have to move — but in almost every case rolling it over is the right call, directly into your new employer’s plan or into an Individual Retirement Account (IRA), so the tax shelter stays intact. Done as a direct, trustee-to-trustee transfer, a rollover is tax-neutral: nothing is withheld and no penalty applies, because the money never passes through your hands. The guide to IRAs covers the rollover mechanics.

You can sometimes leave a balance behind, but the plan decides: balances over $7,000 can usually stay, while below that a former plan may force you out — auto-rolled to an IRA from $1,000 to $7,000, or paid as a taxable check below $1,000, per SECURE 2.0. That auto-rollover lands in a Traditional IRA and keeps the tax shelter intact. The forced check does not. It hands you the balance minus 20% withheld for taxes, and before 59½ the 10% early-withdrawal penalty applies on top, so a small balance can lose nearly a third on the way out.

Cashing out is the one option to avoid: the taxes and penalties make it the most expensive exit.

What Jordan should type

Back to Jordan and that 3%. Had someone walked her through the screen, she’d have set the deferral to at least her match threshold, 6% under the common formula, collecting every matched dollar; then aimed for the order-of-operations target of 15% of gross as her raises came in. She’d have picked traditional or Roth from her bracket today versus the one she expects in retirement, and left the investments to a single low-cost fund.

The deferral percentage is the decision. Set it right and the rest settles into place in order: the tax treatment, the match, the fund choice. Open your benefits portal, find the field Jordan found, and set the number nobody told her to set.