What is a 401k? The US retirement plan and its advantages

There are many ways to provide for retirement. One of the most popular in the USA is the 401 k retirement plan. It's an employer-sponsored program in which part of the employee's salary is automatically transferred into a special account. The federal government gives these contributions tax advantages, which means the amounts paid in can be deducted from income tax. On top of that, the savings grow tax-free as long as they stay in the 401 k account. Thanks to the tax breaks and tax-free growth, considerable sums can build up over time. The 401 k also offers broad diversification across different asset classes, which minimizes the risk of losses.

Can you benefit too? In this article we explain how the 401 k plan works, which contribution and cost limits apply, and what the pros and cons are. We also show you how to use it to save for retirement while taking advantage of the tax benefits.

1The US retirement system: how does the 401 k work?

The US retirement system is complex and rests on several pillars, including the state pension (Social Security), private pension plans and individual savings programs such as the 401 k.

The 401 k is an individual savings plan that employers offer to help employees save for retirement. What makes it special is that contributions get tax advantages and the savings can grow tax-free as long as they stay in the 401 k account.

Contributions to the 401 k plan are deducted directly from the employee's salary and transferred to the 401 k account. The employer can also contribute to the plan, adding a fixed amount or a percentage of the employee's salary.

The contribution limits for the 401 k plan are set each year by the Internal Revenue Service (IRS). In 2026, the limit for employee contributions is $24,500 a year. Employees aged 50 and over can make additional "catch-up" contributions to save faster.

The money in the 401 k account is usually invested in a selection of mutual funds or similar investment vehicles. The choice of funds depends on the employer offering the 401 k plan and can range from simple stock and bond funds to more complex asset classes such as hedge funds or private equity.

The money saved in the 401 k account normally can't be withdrawn before age 59.5 without penalty taxes and fees. After that, it can be paid out in installments or as a lump sum, and these payouts are generally subject to ordinary income tax.

All in all, the 401 k is a key part of the US retirement system and helps many employees save for retirement. With its tax advantages and wide range of investment options, employees can build wealth over time and benefit from the long-term returns of the capital markets.

The 401 k for small businesses

Offering a 401 k retirement plan is becoming more and more important, especially at small businesses. No surprise, since the 401 k retirement plan offers big advantages to employers and employees alike. The company gets significant tax breaks and deductions, and for employees, whether an employer offers a 401 k has become essential when choosing a job.

2What are the advantages of the 401 k plan?

Tax advantages: Contributions to the 401 k plan are tax-deductible, which lowers your tax bill.

Tax-free growth: Your savings grow tax-free as long as they stay in the 401 k account.

Employer contributions: Employers can contribute to the plan, which can help increase your savings.

Wide choice of investments: The investment options depend on the employer and range from simple stock and bond funds to more complex asset classes such as hedge funds or private equity.

Flexible payouts: After age 59.5, the money can be paid out in installments or as a lump sum, giving employees flexibility in planning their retirement finances.

3What are the disadvantages of the 401 k plan?

High fees: Fees for the 401 k plan can be high, especially if the employer doesn't offer low-cost funds. These fees can eat into the plan's returns and lower the overall return.

Limited access to your money: The money in the 401 k account normally can't be withdrawn before age 59.5 without penalty taxes and fees. That can be a drawback if employees need the money early.

Tax on payouts: When money is paid out of the 401 k account, the payouts are normally subject to income tax. If you're in a higher tax bracket at payout than when you contributed, your tax bill can be higher.

No guaranteed return: The 401 k plan is an investment program and doesn't guarantee any particular return. The employee's savings can therefore shrink because of market or investment losses.

4Maximum contributions and costs of the 401 k

For 2026, the 401 k contribution limits are $24,500 a year for employees under 50 and $32,500 for employees aged 50 and over ($24,500 plus $8,000 "catch-up"). Anyone who turns 60 to 63 in 2026 may make a higher catch-up contribution of $11,250, for a total of $35,750. Your employer can contribute on top: under IRC § 415(c), the combined maximum is $72,000, up to $80,000 with catch-up contributions and up to $83,250 for those aged 60 to 63. Source: IRS Notice 2025-67 of November 13, 2025. The plan's costs depend on the employer and the investment options and should be reviewed carefully to make sure they are reasonable.

6How can you benefit from the 401 k plan?

If you live and work as an employee in the USA, joining a 401 k plan is fairly simple. Your employer usually offers the plan, and you just make your contributions.

If you live in the USA but aren't employed, it's a little more complicated.
The self-employed and freelancers can sign up for a Solo 401 k plan, which offers them similar advantages to a traditional 401 k plan.

To sign up for a Solo 401 k plan, you first open an account with a financial institution that offers the plan. Then you choose and set up your contributions, either as traditional or Roth contributions. Keep the annual contribution limits and tax requirements in mind.

Mount Bonnell Advisors can help you understand the plan and make the best decisions for your individual needs.

If you don't live in the USA, you normally can't join a 401 k plan. You could, however, consider investing in a US ETF that puts part of its assets into companies that also offer 401 k plans. That way you can benefit indirectly from the advantages of the 401 k plan.

Good to know:
A decision like this shouldn't be taken lightly. There are many rules and regulations to follow, and it can be hard to keep track of them all.

Mount Bonnell Advisors can help you weigh the pros and cons, understand the different options and make the right decision for your individual needs. Contact us today for a personal consultation. For an overview of your tax obligations as an individual in the USA, see our page Services for individuals.

In short

• The 401(k) is an employer-sponsored savings plan: part of your salary goes into your own account with tax advantages and grows there tax-free.
• In 2026, employees can contribute up to $24,500, $8,000 more from age 50, and $11,250 more at ages 60 to 63; including the employer's share, up to $72,000 is possible.
• Withdrawals before age 59.5 usually trigger penalty taxes; after that, payouts are taxed as income.
• The downsides: fees, limited access and market risk.
• The self-employed in the USA use the Solo 401(k); if you don't live in the USA, you generally can't take part.

How we help you

• Your US Tax ReturnForm 1040 or 1040-NR, handled in English.
• PayrollPayroll, payroll taxes and filings for your employees in the USA.
• US Tax ConsultationYour US tax question, answered by people who know both sides.
• Tax structureA clean structure between parent company and US subsidiary, or between you and your US company, coordinated with your accountant.