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💸 Money Guide: 401(k)
The Complete Guide to 401(k) Plans: How They Work, Why They Matter, and How to Max Out Your Retirement
Brandon Smith
May 25, 2025
tl;dr: A 401(k) is an employer-sponsored retirement account that lets you contribute pre-tax (Traditional) or after-tax (Roth) dollars, grow investments tax-deferred or tax-free, and enjoy powerful compounding over time. Many employers offer matching contributions. Traditional 401(k)s reduce taxable income now but are taxed at withdrawal. Roth 401(k)s grow and withdraw tax-free. Solo 401(k)s are designed for self-employed individuals and combine high contribution limits with flexibility.
Money Guide: 401(k)
401(k)
401(k)s: A Comprehensive Guide to Workplace and Solo Retirement Plans
A 401(k) is one of the most powerful tools for building retirement savings—especially when paired with employer matching and tax advantages. Whether you’re contributing through work or running your own business, understanding the nuances of Traditional, Roth, and Solo 401(k) plans can help you optimize for both taxes and long-term growth.
This guide breaks down eligibility, contribution limits, tax treatment, withdrawal rules, and strategic use cases for each type.
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Types of 401(k) Plans
Plan Type | Who It's For | Contributions | Tax Treatment |
|---|---|---|---|
Employees with employer plans | Pre-tax (lower income now) | Tax-deferred growth; taxed at withdrawal | |
Employees with Roth option | After-tax (no deduction) | Tax-free growth and withdrawals | |
Self-employed individuals | Employer + employee side | Depends on Traditional vs. Roth setup |
Eligibility and Contributions for 401(k)s
Traditional & Roth 401(k): Available through employers. Some employers offer both; some offer only one.
Solo 401(k): You must have self-employment income with no full-time employees (except a spouse).
Contribution Deadlines: Employee deferrals must be made by Dec 31; employer contributions (including to Solo 401(k)s) can be made up until the tax filing deadline (plus extensions).
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401(k) Contribution Limits for 2025
Type | Limit |
|---|---|
Employee elective deferral | $23,000 |
Catch-up contribution (age 50+) | +$7,500 (total: $30,500) |
Solo 401(k) total limit | $69,000 (or $76,500 w/ catch-up) |
Solo 401(k)s allow you to contribute as both the employee and the employer, maximizing your tax-advantaged space.
401(k) Tax Treatment
Traditional 401(k):
Contributions: Pre-tax; reduces taxable income today.
Growth: Tax-deferred.
Withdrawals: Taxed as ordinary income in retirement.
RMDs: Required beginning at age 73.
Roth 401(k):
Contributions: After-tax; no immediate deduction.
Growth: Tax-free.
Withdrawals: Tax-free if age 59½ and account held ≥5 years.
RMDs: Yes—unless rolled into a Roth IRA, which avoids RMDs.
Solo 401(k):
Can be Traditional, Roth, or both.
Employer contributions must be pre-tax.
Subject to same withdrawal and RMD rules depending on plan type.
Self-employed and considering a Solo 401(k)?
Check out the Carry Solo 401(k) review for 2025
401(k) Withdrawal Rules
Early Withdrawals: Subject to income tax + 10% penalty if under age 59½ (unless an exception applies).
Hardship Withdrawals: Allowed in specific cases but may still incur penalties.
Loans: Many employer 401(k)s allow borrowing from your balance (up to $50,000 or 50% of vested amount).
401(k) Investment Strategies
Your 401(k) is only as good as the investments inside it. Choose based on time horizon and risk tolerance:
Young Savers: Focus on stock-heavy index funds or target-date funds.
Mid-Career: Begin shifting to a mix of stocks and bonds.
Pre-Retirement: Emphasize preservation with more fixed-income and less equity risk.
Bonus tip: Rebalance at least annually to stay aligned with your risk profile.
Traditional vs. Roth 401(k): Key Differences
Feature | Traditional 401(k) | Roth 401(k) |
|---|---|---|
Contributions | Pre-tax | After-tax |
Growth | Tax-deferred | Tax-free |
Withdrawals (retirement) | Taxed as ordinary income | Tax-free (if qualified) |
RMDs | Yes, starting at age 73 | Yes (unless rolled into Roth IRA) |
Income limits | None | None |
Strategic 401(k) Use Cases
High Earners: Use Traditional 401(k) to lower current taxable income.
Young Professionals: Consider Roth 401(k) while in a low tax bracket.
Self-Employed: Open a Solo 401(k) to maximize your contribution space.
Dual Strategy: Some plans allow split contributions between Traditional and Roth—diversifying your tax exposure.
401(k) Pro Tips
Get the Match: If your employer offers a match, always contribute at least enough to earn the full amount—it's free money.
Rollovers: Leaving your job? Roll your 401(k) into an IRA or your next employer’s plan to avoid taxes and penalties.
Roth Conversions: Consider converting Traditional to Roth in low-income years to "fill up" lower tax brackets.
💡 Lowcountry Ledger’s Take: A 401(k) is one of the smartest tools for building long-term wealth. With high contribution limits, tax advantages, and potential employer matching, it’s a no-brainer for most workers. For the self-employed, a Solo 401(k) offers the same perks—plus flexibility. Traditional and Roth options each have their place, depending on your tax outlook. Either way, don’t leave this opportunity on the table.
Self-employed and considering a Solo 401(k)?
Check out the Carry Solo 401(k) review for 2025
401(k) Frequently Asked Questions (FAQ)
✅ General Questions
Question: What is a 401(k)?
Answer: A 401(k) is an employer-sponsored retirement savings plan that allows you to contribute pre-tax or after-tax (Roth) income and invest it for long-term growth.
Question: Who can open a 401(k)?
Answer: Traditional 401(k)s are offered through employers. If you’re self-employed with no employees (other than a spouse), you can open a Solo 401(k).
Question: How much can I contribute in 2025?
Answer: You can contribute up to $23,000 in employee deferrals. If you're 50 or older, you can make an additional $7,500 catch-up contribution.
Question: Can I open a 401(k) on my own?
Answer: If you're self-employed, you can open a Solo 401(k), which is designed specifically for individuals who run their own business without any full-time employees.
Question: How much does it cost to open a 401(k)?
Answer: Costs vary by provider. Some Solo 401(k)s have no setup fees, while others may charge a few hundred dollars plus optional ongoing fees. Employer-sponsored plans are typically free for employees.
Question: How much do I need in my 401(k) to get $1,000 a month?
Answer: To generate $1,000 a month ($12,000 a year) in retirement, you'll generally need around $300,000 in your 401(k), assuming a 4% annual withdrawal rate.
Question: How do I properly set up a 401(k)?
Answer: If you're employed, enroll through your employer’s plan and choose your contribution amount and investments. If you're self-employed, you can open a Solo 401(k) through a provider, complete the required paperwork, and set your contributions based on your income.
💵 Contributions & Matching
Question: Is employer matching free money?
Answer: Yes—if your employer matches contributions, that’s essentially a bonus for your retirement savings. Always contribute at least enough to get the full match.
Question: What’s the difference between pre-tax and Roth 401(k) contributions?
Answer:
Pre-tax (Traditional): Lowers your taxable income now, but you’ll pay taxes when you withdraw in retirement.
Roth: Contributions are taxed now, but withdrawals in retirement are tax-free.
Question: Can I contribute to both a 401(k) and an IRA?
Answer: Yes, though your ability to deduct Traditional IRA contributions may be limited depending on your income and participation in a workplace plan.
📈 Investment & Growth
Question: How is my 401(k) money invested?
Answer: You choose from a menu of investment options (usually mutual funds, target-date funds, or ETFs). Your money grows tax-deferred (or tax-free in a Roth).
Question: What’s a target-date fund?
Answer: It’s a one-stop investment option that automatically shifts to a more conservative allocation as you approach retirement.
Question: Can I lose money in a 401(k)?
Answer: Yes. Your returns depend on market performance, though diversification and time in the market help reduce long-term risk.
🚨 Access & Withdrawals
Question: When can I take money out?
Answer: Without penalty, you can begin withdrawals at age 59½. Earlier withdrawals typically face a 10% penalty plus taxes, unless you qualify for an exception.
Question: What if I change jobs?
Answer: You can leave your 401(k) where it is, roll it over into an IRA, or move it into your new employer’s 401(k) plan.
Question: Do I have to withdraw at some point?
Answer: Yes—Required Minimum Distributions (RMDs) start at age 73 for Traditional 401(k)s. Roth 401(k)s are also subject to RMDs unless rolled into a Roth IRA.
👤 Solo 401(k) Questions
Question: Who qualifies for a Solo 401(k)?
Answer: Any self-employed individual or business owner with no full-time employees (except a spouse).
Question: How much can I contribute to a Solo 401(k)?
Answer: You can contribute both:
Employee deferral: Up to $23,000
Employer profit-sharing: Up to 25% of net income
Combined total limit: $69,000 in 2025 (or $76,500 if age 50+)
Question: Can I open a Solo 401(k) if I also have a job with a 401(k)?
Answer: Yes, but the employee deferral limit ($23,000) is shared across both plans.
401(k) Glossary
401(k): A tax-advantaged retirement account offered by employers (or set up by the self-employed) allowing employees to save and invest a portion of their paycheck.
After-Tax Contributions: Contributions made with post-tax dollars; typically used in Roth 401(k)s.
Automatic Enrollment: A feature where employees are automatically enrolled in the 401(k) plan unless they opt out.
Catch-Up Contributions: Additional contributions allowed for individuals age 50 or older. In 2025, it's $7,500 extra.
Contribution Limit: The maximum amount you can contribute each year. In 2025, the employee deferral limit is $23,000.
Custodian: The financial institution that holds and manages assets in the 401(k) plan.
Deferral: The portion of salary an employee chooses to contribute to a 401(k) plan.
Defined Contribution Plan: A retirement plan where contributions are defined but future benefits depend on investment performance (e.g., 401(k)).
Discretionary Match: An employer match that may vary from year to year, at the employer’s discretion.
Early Withdrawal Penalty: A 10% penalty applied to withdrawals made before age 59½ (unless an exception applies).
Employer Contribution: Funds your employer adds to your 401(k), either as a match or profit-sharing.
ERISA (Employee Retirement Income Security Act): Federal law that sets minimum standards for retirement plans, including fiduciary responsibilities and participant protections.
Hardship Withdrawal: A distribution made due to immediate and heavy financial need. Penalties and taxes may still apply.
In-Service Withdrawal: Taking a distribution from a 401(k) while still employed, typically restricted unless age 59½ or older.
Investment Options: The mutual funds, ETFs, or other assets you can choose within your 401(k) plan.
Loan (401(k) Loan): A feature that allows borrowing from your 401(k), usually up to $50,000 or 50% of your vested balance.
Limit (Contribution Limit): See “Contribution Limit.”
Liquidity: The ease with which assets can be accessed or converted into cash. 401(k) funds are not liquid without penalty until retirement age.
Match (Employer Match): A percentage of your contributions your employer adds to your 401(k)—e.g., 100% match on the first 5%.
Plan Administrator: The entity responsible for managing the 401(k) plan, often your employer or a third-party provider.
Pre-Tax Contributions: Contributions made before taxes are deducted, reducing your taxable income now (used in Traditional 401(k)s).
Profit-Sharing Contribution: An employer contribution that is not tied to employee deferrals; more common in Solo 401(k)s.
Rollover: Moving funds from one retirement plan (like a 401(k)) to another (like an IRA or new employer plan) without tax penalties.
Roth 401(k): A 401(k) that allows after-tax contributions and tax-free withdrawals in retirement if qualified.
RMD (Required Minimum Distribution): The minimum amount you must withdraw annually starting at age 73 for most 401(k)s.
Safe Harbor 401(k): A plan that automatically satisfies IRS nondiscrimination rules by meeting specific employer contribution requirements.
Self-Directed 401(k): A 401(k) with expanded investment options beyond typical mutual funds, sometimes including real estate or private equity.
Solo 401(k): A 401(k) plan for self-employed individuals or business owners with no full-time employees (other than a spouse).
Target-Date Fund: A mutual fund that automatically adjusts its asset allocation as you approach retirement.
Traditional 401(k): The standard pre-tax retirement account; withdrawals are taxed in retirement.
Vesting: The degree to which employer contributions belong to the employee. Some matches are subject to a vesting schedule.
Withdrawal: Taking money out of a 401(k); may be subject to taxes and penalties depending on timing and plan rules.
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