What is a 401(k) and how does employer matching work?

You’ll find similar retirement savings plans out there, too. Nonprofits and schools can offer a 403(b), and government workers may have a 457(b). They work pretty much the same way.

How does a 401(k) work?

You choose a percentage of your pay to contribute, like 3% or 5%. Your employer takes that amount out of each paycheck and puts it into your account. You then choose how to invest it from a list of options, usually mutual funds. Lots of plans now enroll new workers automatically, often at 3% or more of pay. You can change that or opt out.

Traditional vs. Roth 401(k)

Many plans offer both the standard 401(k) and Roth plans, but they’re not the same.

• Traditional 401(k): Your contributions come out before income taxes, so your taxable income is lower today. You pay taxes when you withdraw the money (after you retire).
• Roth 401(k): Your contributions come out after taxes, so there's no tax break off the bat, but in retirement, withdrawals can be tax-free if you follow the rules.

If your income is low now and likely to rise, a Roth account is probably the better choice. If you need every bit of take-home pay today, a traditional account can stretch your paycheck a little further. Splitting between the two is fine, too.

How does employer matching work?

Employer matching is money your employer adds based on what you contribute. Plans vary, but a lot of companies use one of these formats:

• Dollar-for-dollar up to 4%: You can contribute 4% of your pay, and your employer adds another 4% on top of it.
• 50 cents per dollar up to 6%: You contribute 6%, and your employer adds 3% on top.

What is vesting?

Your contributions always belong to you, but some employers make you stay on the job for a specified time before their match is yours. This is called “vesting.”

For example, a plan might vest 20% of the match each year, so you own all of it after five or six years. Others vest everything at once after a few years. Ask HR to explain your employer’s plan. If you're thinking about leaving, check how close you are to being fully vested.

Are there contribution limits?

Currently, you can contribute up to $24,500 of your own money. Workers 50 and older can add an extra $8,000, and those aged 60 to 63 can add up to $11,250 instead. Employer matches don't count toward your personal limit.

Most people won't come close to these limits, and that's fine. Start with whatever gets you the full match. Limits change regularly, so make sure you know the current cap.

Fees and investments

Each plan gives you access to different investments. If you're not sure what to pick, many offer target-date funds, which include a mix of stocks and bonds and automatically get more conservative as your retirement year approaches.

Look for low fees when deciding. Even a 1% difference in yearly costs can mean thousands of dollars less over a career.