What Are the Benefits of Investing in a 401(k) Plan?

During my time as a licensed financial coach, I learned firsthand about 401(k) plans. I gained insight when a client implemented a plan in his company.

A 401(k) plan benefits employees who want to save for retirement. Employer matches, portability, and favorable tax treatment encourage employees to participate in these plans.  

What a 401(k) Plan Is

A 401(k) plan is an employer-provided, voluntary savings program named after the federal tax code. Employees who participate in a plan have a defined amount taken from their paychecks and invested in their accounts. The contribution limit for a 401(k) plan in 2025 is $23,500 and can change annually.

Investment options in a 401(k) plan typically include mutual funds, exchange-traded funds, and target-date funds. Contributions are deducted from employees’ paychecks before income tax is calculated and grow tax-deferred.

The following are the benefits of investing in a 401(k) plan.

Fiduciary Standards

Because a 401(k) plan falls under the Employee Retirement Income Security Act (ERISA), employers must ensure it prioritizes the employees’ best interests. Since employers are held to fiduciary standards, the plan’s costs must be reasonable, investment options must be stable, and fees and other key information must be disclosed.

Company match

Many employers match employees’ 401(k) plan contributions dollar for dollar or 50 cents to the dollar, up to a set limit. This match provides additional retirement savings at no cost to the employees.

Many employers require employees to remain for a set time, typically up to 5 years, before the matches are fully vested. If an employee leaves the company during this period, they can transfer their 401(k) plan contributions to a designated retirement account, but lose the employer’s contributions.

Late-saver contributions

For most employees, the investment limit in a 401(k) plan is $23,500 in 2025. However, employees who are at least 50 years old can invest up to $7,500 in catch-up contributions in 2025, increasing the limit to $31,000. Employees aged 60-63 can invest additional catch-up contributions of $11,250 in 2025, increasing the limit to $42,250.

Withdrawals for Emergencies

Employees who withdraw funds from their 401(k) plan before age 59 ½ typically pay a 10% early withdrawal penalty and income taxes. However, some employers allow participants to borrow from their account and pay back the funds plus interest:

• The maximum loan amount can be half the vested amount in the account up to $50,000.

• Repayment is capped at 5 years.

• Hardship withdrawals can be penalty-free if they meet strict requirements, such as the employee becoming disabled or having medical expenses that exceed 7.5% of their adjusted gross income.

Tax breaks

Contributions to a traditional 401(k) plan are pre-tax and grow tax-deferred:

• Distributions are taxed after withdrawal.

• Because the plan is designed for retirement, withdrawals typically are made at age 59 ½ or later.

• Since contributions are not considered income, they reduce an employee’s income and can put them in a lower tax bracket.

• The employee might have a lower tax burden while saving money for retirement.

• Because the money grows tax-deferred, the net gains and dividends are not taxed.

• Compounding interest provides additional retirement income.

Conversely, a Roth 401(k) is funded with after-tax dollars:

• The contributions grow tax-free.

• Penalty-free withdrawals can be made when the account is held for at least 5 years.

• Withdrawals after age 59 ½ are taxed on only the company match, not the contributions or earnings.

Flexibility When Leaving a Job

Employees typically have four options for their 401(k) plan when leaving a job:

• Withdrawing the balance, which can incur an early withdrawal fee and/or paying income taxes

• Leaving the money in the current 401(k)

• Transferring the money to the new employer’s 401(k)

• Rolling the current balance into an Individual Retirement Account (IRA)

A licensed financial professional can help determine the best option for your circumstances.

*This information is for educational purposes only.