Preparing for Retirement in the U.S.: The Complete Guide to 401(k)

We all live in a capitalist society. However, most of us are never educated about the most critical aspects of capitalism—investment and retirement—before we enter the real world. During my 25 years of working in companies in the U.S., I’ve been surprised by how many people don’t fully understand the 401(k) system.

If you’re working in the U.S., the 401(k) is a retirement savings vehicle you absolutely must understand. After reading this post, you’ll know the structure, advantages and disadvantages, and how to best utilize a 401(k)!

What is a 401(k)?

A 401(k) is a tax-advantaged retirement savings account sponsored by the U.S. government. You can only participate through your employer, and it automatically saves and invests a portion of your salary.

Name origin: It comes from Section 401(k) of the Internal Revenue Code.

How Does It Work?

When you get a job, your employer will provide information to enroll in a 401(k) through a designated financial institution such as Fidelity, Vanguard, Merrill Lynch, E*TRADE, Charles Schwab, etc. You choose a specific contribution amount or percentage, which is then automatically deducted from your paycheck.

 

Most employers offer a matching contribution—for example, if the company offers a 50% match, and you contribute $100, the employer adds $50, making your total contribution $150 per pay period.

The money doesn’t just sit there—it is invested in various funds like mutual funds, money market funds, and target retirement funds to grow until retirement. You can choose your preferred funds for the investment.

 

Types of 401(k) Accounts and Tax Benefits

Types of 401(k) are: 

• Traditional 401(k) Pretax

• Traditional 401(k) After tax

• Roth 401(k)

	When to be taxed	For whom
Traditional 401(k) (Pre-tax)	Contributions are tax-deductible, but withdrawals during retirement are taxed as income.	People with high current income who expect lower income in retirement.
Traditional 401(k) (After-tax)	Contributions are taxed, and qualified withdrawals are tax-free. Can be converted to Roth 401(k).	People expecting higher tax rates in the future or strong investment returns.
Roth 401(k)	Contributions are taxed, but qualified withdrawals are tax-free.	People with lower current income and higher future tax expectations.

Investments and Growth

The money in your 401(k) is not just savings. it is invested in:

• Equity (stock) mutual funds

• Bond funds

• Target date funds (automatically adjusted based on retirement year)

Withdrawals and Penalties

You can withdraw penalty-free starting at age 59½.

 

Rule of 55:

• If you leave your job after age 55, you can withdraw from your last employer's 401(k) without penalty.
  (Note: This rule does not apply to IRAs.)

• Before 59½, early withdrawals typically incur 10% early withdrawal penalty + income taxes.

 

Exceptions to the 10% penalty before age 59½:

Condition	Penalty Waived	Notes
After 59½	✅ Yes	Standard withdrawal age
Rule of 55 (age 55+ and separated from service)	✅ Yes	Only applies to 401(k), not IRAs
Substantially Equal Periodic Payments (SEPP) - 72(t)	✅ Yes	Must follow strict IRS rules. Minimum 5 years or until age 59½. Cannot change payment once set.
Disability	✅ Yes	Must meet IRS definition
Hardship Withdrawals	⚠️ Partial	Complex requirements. Taxes may still apply.

 

2025 Contribution Limits

• Individual Contribution Limit: $23,500

• Catch-up (age 50+): Additional $7,500

• Total Contribution (Employee + Employer):

• Under 50: $70,000

• 50 and over: $77,500

Employer Matching: Don’t Miss Out!

Most companies match 50% ~ 100% of employee contributions (typically 3~6% of salary).

Example: If you contribute 5% of your salary, the company may contribute another 3%. Note: The employer match is “free money.”. Make the most of it!

 

What If You Change Jobs or Retire?

• Option 1: Rollover to an IRA.
  You can move your 401(k) to an Individual Retirement Account (IRA) without penalty.

• Pros: IRAs offer more investment choices (individual stocks, ETFs, etc.)

• Cons: Rule of 55 no longer applies after rollover.

• Option 2: Leave it with your former employer:

• Pros: Rule of 55 still applies for penalty-free withdrawals before age 59½

• Cons: Limited investment options

• Option 3: Transfer to your new employer’s 401(k)

• Option 4: Cash Out:

• Usually subject to 10% penalty + taxes

• Rule of 55 exception applies if age 55+

• No penalty if age 59½ or older

Tips for Maximizing Your 401(k)

• Always contribute at least enough to get the full employer match

• Think long-term investment — this is retirement money

• Choose low-fee funds

• Align your investments with your expected retirement timeline
  
  

💡Tip: Some employers offer a “Self-Brokerage” option, letting you invest in any investment items such as indivudual stocks or ETFs. Check with your plan provider.