What a 401(k) actually is
A 401(k) is a workplace-sponsored, tax-advantaged retirement account named after the section of the Internal Revenue Code that created it. You authorise your employer to defer part of your paycheck — pre-tax for a Traditional 401(k), post-tax for a Roth 401(k) — into an investment account in your name. Many employers add a matching contribution on top, often the closest thing to free money in personal finance. Investments inside the account grow without annual tax drag and you pay tax (or not, in the Roth case) when you take money out in retirement.
Contribution limits as of the current tax year
The IRS sets three limits that the calculator uses internally. The employee elective deferral limit caps what you can contribute from your own paycheck. Workers age 50 and older can add a catch-up contribution on top of that base limit. A newer enhanced catch-up tier applies to ages 60 through 63, allowing an even larger total. Finally, the combined limit — your contributions plus the employer match plus any after-tax contributions — is also capped each year. The exact dollar amounts are stored in the CONFIG object at the top of the calculator script and update annually; we deliberately do not hard-code year numbers into this page because the IRS adjusts them for inflation.
Formula: balance at retirement
The balance projection compounds month by month. For each month the script:
- applies investment return to the running balance:
balance × (1 + r/12), - adds your contribution for the month:
(salary × contrib%) / 12, - adds the employer match, capped by the match-limit-% input:
min(contrib%, matchLimit%) × match% × salary / 12, - grows salary at the start of each new year by the salary-increase %.
The annuity-style equivalent of the closed-form FV formula for a level contribution is:
Employer match: worked examples
Example A — 50% on the first 6%. Salary $80,000. Contribute 6% ($4,800). Employer adds 50% × 6% × $80,000 = $2,400. If you only contribute 3% ($2,400), the match drops to $1,200 — you have left $1,200 on the table.
Example B — Dollar-for-dollar on the first 4%. Salary $80,000. Contribute 4% ($3,200). Employer adds 100% × 4% × $80,000 = $3,200. Contribute 8% and the match is still $3,200; the employer cap is fixed at 4%.
Example C — Tiered. Tier 1: 100% on first 3%. Tier 2: 50% on next 2%. To capture the full match on an $80,000 salary you must contribute at least 5% (= $4,000) and the employer adds $2,400 + $800 = $3,200. Mode 3 of this calculator finds that breakpoint automatically.
Pros and cons of a 401(k)
Pros. Tax-deferred (Traditional) or tax-free (Roth) growth. The employer match is an instant 25-100% return depending on its size. Contributions are tax-deductible in the Traditional case, lowering current taxable income. Annual limits are higher than IRAs. Balances enjoy ERISA creditor protection in bankruptcy and most lawsuits. Loans, hardship withdrawals and rollovers preserve some flexibility.
Cons. The plan's menu is limited to what the sponsor chose, often ten to thirty mutual funds. Expense ratios can be higher than retail equivalents, especially in small-employer plans. Money is illiquid before 59½ without a 10% penalty. Employer match is subject to vesting. New hires may face a waiting period of up to a year before they can join. Required Minimum Distributions force taxable income out starting at age 73 for traditional balances.
401(k) versus a defined-benefit pension
A defined-benefit pension promises a specific monthly income for life based on years of service and final salary; the employer takes the investment risk. A 401(k) is defined-contribution — the contribution is fixed but the eventual benefit depends on market performance. The risk has shifted to you. Pensions reward long tenure at one employer; 401(k)s are portable. For most private-sector US workers the pension has been replaced entirely by the 401(k) over the past three decades.
Vesting: when the match is really yours
Vesting determines how much of the employer match you keep if you leave. Your own deferrals are 100% vested immediately, always. There are two common schedules:
- Cliff vesting: 0% vested until a milestone (often 2-3 years) then 100% all at once. Walk out one day before the cliff and you forfeit every employer dollar.
- Graded vesting: a percentage each year. A common 5-year graded schedule vests 20% per year, reaching 100% after year 5.
Federal law caps the maximum schedule employers can use; many offer faster vesting as a recruiting tool.
Early withdrawal: the real cost
Taking money out of a Traditional 401(k) before age 59½ triggers ordinary income tax at your marginal rate plus a 10% federal early-withdrawal penalty. Most states tax the distribution too. A $20,000 withdrawal for someone in the 22% federal bracket and a 5% state can shrink to roughly $12,600 in hand after $4,400 federal + $1,000 state + $2,000 penalty. Mode 2 of this calculator does that math for any combination.
Financial hardship qualifying conditions for an in-service hardship distribution typically include: medical expenses for the participant, spouse or dependants; costs to buy a primary residence; tuition and related educational fees for the next twelve months; payments to prevent eviction or foreclosure on a primary residence; burial and funeral expenses; and repair of casualty damage to a primary residence.
Non-financial hardship penalty exceptions that waive the 10% penalty (but not ordinary income tax) include: total and permanent disability of the participant; substantially equal periodic payments (Rule 72(t)); separation from service in the year you turn 55 or later; a Qualified Domestic Relations Order following divorce; birth or adoption (up to a capped amount); IRS levy on the account; federally declared disaster distributions; certain reservist call-ups; and qualified medical expenses exceeding 7.5% of AGI.
Distribution options at retirement
- Lump sum: take the entire balance at once. Simple, but triggers a single large tax bill that can push you into a higher bracket.
- Installments: systematic monthly or quarterly payments from the plan. Smooths the tax hit but you stay subject to the plan's investment menu and fees.
- Rollover to an IRA: the most common choice. Tax-free transfer to an IRA opens up the entire retail investment universe and gives more control over RMDs.
- Annuity conversion: use part of the balance to buy a single-premium immediate annuity that pays a guaranteed monthly income for life. Useful for hedging longevity risk.
- Defer: if the plan allows it, leave the money in the 401(k) past separation. Useful if the plan has unusually low fees, but RMDs still apply at 73.
The 4% rule, applied to a 401(k)
The 4% rule, derived from the Trinity Study, suggests that withdrawing 4% of the retirement balance in the first year and adjusting that dollar amount for inflation thereafter has historically lasted about 30 years across stock-and-bond mixes. Apply it directly to the projected 401(k) balance for a rough sustainable income, but remember: it is a guideline, not a guarantee, and ignores taxes on Traditional balances. See the dedicated retirement calculator for a fuller withdrawal model.
Required Minimum Distributions
Once you reach age 73 (under current rules) the IRS requires you to withdraw a minimum amount from Traditional 401(k) and IRA accounts each year. The amount equals the prior-year-end balance divided by an IRS life-expectancy factor that ranges from about 27 in your seventies to lower numbers as you age. Missing an RMD triggers an excise tax — currently 25%, reduced to 10% if corrected promptly. Use the RMD calculator for the exact dollar figure. Roth 401(k) balances no longer have RMDs during the original owner's lifetime as of the current tax year.
Solo 401(k) for the self-employed
A Solo 401(k) is for sole proprietors and one-owner businesses with no employees other than a spouse. You wear two hats: employee, deferring up to the standard employee limit, and employer, contributing up to 25% of net self-employment earnings, both subject to the combined annual cap. Roth versions are now widely available. Compared with a SEP-IRA at the same income, the Solo 401(k) almost always allows higher total contributions and supports loans, although it adds a small amount of paperwork once the balance exceeds the Form 5500-EZ threshold.
Roth 401(k) versus Traditional 401(k)
The arithmetic difference is the timing of taxation. Traditional contributions are made pre-tax, lowering current taxable income; you pay tax on the entire balance at withdrawal. Roth contributions are after-tax now and qualified withdrawals — both principal and growth — are tax-free in retirement. Two practical points: your contribution limit is shared between Traditional and Roth, not doubled; and Roth 401(k) balances no longer face RMDs during the original owner's lifetime under current rules. Choose Roth if you expect a higher tax rate in retirement than today, or simply want tax diversification. The dedicated Roth IRA calculator models the same idea for IRAs.
Edge cases
- Contribution exceeds the IRS limit. If your percentage × salary lands above the elective deferral cap, the calculator caps the deferral at the legal limit and warns you. Excess deferrals must be returned by April 15 of the following year or face double taxation.
- Highly Compensated Employee (HCE) limits. If your plan fails non-discrimination tests, HCEs may have to take back part of the year's contributions. Safe-harbor plans avoid this.
- True-up missing. Front-loading deferrals (e.g. maxing out by July) can forfeit later-year matches in plans without a true-up provision. Spread contributions evenly if your plan lacks one.
- Salary increase outpaces return. If raise % exceeds return %, the contribution side of the projection dominates and the chart looks more linear than exponential.
- Already past 59½. Mode 2 zeroes the penalty automatically — only ordinary income tax remains.
What to do with the result
- Increase your contribution by 1%. Most plans accept changes at any time. A single percentage point compounded for decades often translates to six-figure differences at retirement.
- Capture every match dollar. If you're contributing below the match limit, raise it immediately — that's a 25-100% instant return on the next dollar.
- Decide Traditional vs Roth. If you expect a higher tax rate in retirement than today (early career, low bracket now), prefer Roth.
- Avoid the early-withdrawal hit. Before tapping the 401(k) before 59½, exhaust alternatives — taxable savings, lines of credit, even a 401(k) loan in many cases.
- Plan the rollover. When you leave a job, rolling the balance to an IRA usually expands your investment menu and lowers fees, but compare carefully if your old plan offered institutional-class funds.
Related tools
Use the IRA calculator for the IRA side of the picture, the Roth IRA calculator to compare after-tax savings, the RMD calculator for required distributions after 73, and the retirement calculator for an integrated nest-egg-plus-withdrawal projection.