401(k) Plans
401(k) Plans Explained
The most widely used employer-sponsored retirement plan in America, and one of the most powerful wealth-building tools available.
How a 401(k) Works
A 401(k) is an employer-sponsored defined-contribution plan that allows employees to save a portion of their paycheck before (or after) taxes are taken out. Contributions grow tax-deferred (or tax-free in a Roth 401(k)) until retirement.
Employers may match a portion of employee contributions, this is essentially free money. The plan is named after Section 401(k) of the Internal Revenue Code, which authorized it in 1978.
2025 Contribution Limits
| Category | 2025 Limit |
|---|---|
| Employee Elective Deferral | $23,500 |
| Catch-Up Contribution (Age 50–59, 64+) | +$7,500 |
| Enhanced Catch-Up (Age 60–63, per SECURE 2.0) | +$11,250 |
| Total Employee + Employer Combined | $70,000 (or 100% of compensation) |
| Highly Compensated Employee Threshold | $160,000 |
Traditional vs. Roth 401(k)
Traditional 401(k)
Contributions reduce taxable income today- Investments grow tax-deferred
- Withdrawals taxed as ordinary income
- Required Minimum Distributions at age 73
- Best if you expect lower taxes in retirement
Roth 401(k)
- Contributions made after tax, no deduction
- Investments grow tax-free
- Qualified withdrawals are 100% tax-free
- No RMDs during owner's lifetime (post-SECURE 2.0)
- Best if you expect higher taxes in retirement
Safe Harbor 401(k) Plans
A Safe Harbor 401(k) is a special plan design that automatically satisfies IRS non-discrimination tests, making it particularly attractive for small businesses where owners and key employees want to maximize their own contributions without worrying about whether rank-and-file employees contribute sufficiently.
The employer must contribute one of the following:
- Basic match: 100% of deferrals up to 3% of compensation + 50% of deferrals between 3%–5%
- Enhanced match: 100% match on deferrals up to 4% of compensation
- Non-elective contribution: 3% of compensation to all eligible employees, regardless of whether they contribute
Safe Harbor contributions are immediately 100% vested, meaning employees own them from day one. This is different from discretionary match contributions, which may have vesting schedules of up to 6 years.
Vesting Schedules
Your own contributions are always 100% yours immediately. Employer matching contributions are subject to vesting schedules:
- Immediate vesting, employer match is yours from day one
- Cliff vesting, 0% for up to 3 years, then 100%
- Graded vesting, gradually vests 20% per year over 6 years
Always check your plan's vesting schedule before leaving a job — you may be leaving unvested employer contributions on the table.
Early Withdrawals & Loans
Withdrawals before age 59½ are subject to a 10% early withdrawal penalty plus ordinary income tax. Some plans allow hardship withdrawals or loans. If you take a loan, you typically must repay it within 5 years or the balance becomes a taxable distribution.
If you leave your employer, you generally have 60 days to roll over your 401(k) to an IRA or new employer plan to avoid taxes and penalties.
Maximize Your 401(k) Strategy
Whether you're an employee, business owner, or considering a Safe Harbor plan, Randall Parker can help you design the optimal retirement strategy for your situation.
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