It's not as difficult as you think: Let's say you're starting now at age 25 and your annual salary is $50,000. If you contribute ten percent of your earnings consistently, receive a three percent raise each year and earn an eight percent rate of return on your investment (based on historical S&P 500 averages), you could have more than $2 million in your 401(k) by the time you retire at 65.¹

Depending on your employer's tax status, your plan may be called 403(b) or 457. Both are similar to a 401(k) in how they benefit you.

There are other financial tools available you can use to prepare for retirement, but 401(k)s offer many advantages that other savings and investment vehicles don't. Here are three of them:

• Pre-tax contributions lower your taxable income
• Tax-deferred growth compounds over time
• Employer matching is essentially free money

1. Why are 401(k) contributions tax-advantaged?

The amount you choose to contribute to your 401(k) is deducted from your paycheck before taxes are taken out. As a result, you're paying taxes on a smaller portion of your salary and your overall tax rate may be lower.

Be aware there are limits to how much you can contribute to your 401(k) in any given year. For 2026, the contribution limit is $24,500, or $31,000 if you're 50 or older. Those ages 60–63 can contribute up to $35,750 under the enhanced catch-up provision.

2. When you finally pay taxes on your 401(k), it may be at a different rate

Your 401(k) savings is tax-deferred, not tax-free — you will be taxed on the amounts you withdraw in retirement. Depending on your tax rate in retirement, you could end up paying taxes at a different rate than you pay today. Tax rates often change over time and your annual income in retirement may also be different than what it is in your working years.  

3. What is employer matching and why does it matter?

Many employers offer what is called a "matching contribution." An employer match is when your company contributes money to your 401(k) based on a percentage of what you contribute, up to a set limit.

For instance, if your employer offers a 5-percent match, it means they will contribute the same amount to your account that you do, up to 5 percent of your salary. (You may be able to contribute more, but only the first 5 percent will be matched.)

In other words, your employer is offering you extra money. Think of it as additional salary. Or a bonus. Now ask yourself: if you're not contributing to your 401(k), why are you leaving that money on the table?

A couple of things to remember

You own the money you contribute to your 401(k) — so if you change employers, you can roll it over into your new employer's 401(k) or another qualifying retirement plan account.

Keep in mind that your 401(k) plan operates on the assumption that you are saving for retirement — so once you've put dollars in, there are penalties if you decide to take them out before you reach retirement age. Withdrawing funds before age 59½ typically results in a 10% penalty plus income taxes on the amount withdrawn.

To withdraw the money means you also miss out on the advantage of time and its effect on compound interest.

Saving early and increasing your contributions as you go can help set yourself up for a secure retirement.

Key takeaways

• Contributing to a 401(k) reduces your taxable income because contributions are made with pre-tax dollars.
• Your investments grow tax-deferred, allowing compound interest to work in your favor over time.
• Employer matching contributions are essentially free money that can significantly boost your retirement savings.
• Withdrawing funds before age 59½ typically results in a 10% penalty plus income taxes when the withdrawal is not one of the qualified exceptions, so plan to leave your money invested until retirement.
• Starting early and contributing consistently can help you build substantial retirement savings over your career.