How to Set Up Your 401(k)
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Every new job comes with a stack of documents to sign, initial and, months later, try to remember where they were hastily tossed. Race too quickly through this first-day ritual and you could be leaving thousands of dollars of employee perks on the conference room table.
If you missed the pitch for the company retirement plan during employee orientation, don’t worry. Unlike some employee benefits, such as opting in for insurance or setting up a flexible spending account, you can enroll in a 401(k) year-round.
If you haven’t enrolled already, consider taking care of this 401(k) business today.
6 steps to managing your 401(k)
Even though 401(k)s are called employer-sponsored retirement plans, employers are pretty hands-off when it comes to the setup process. Each worker is in charge of making the investment decisions in their own account.
Your human resources department will make the introduction and explain the high points of how the plan works. (They will not — nor are they allowed to — offer you individualized investment advice.) HR will pass the baton to the company’s 401(k) plan administrator — an outside financial firm — to handle the administrative details, such as enrollment, plan management, account statements and so on.
Next, it’s your turn. Here’s your 401(k) to-do list:
1. Sign up (if your employer hasn’t done it for you)
Some employers automatically enroll new employees in the workplace plan (and all employers will do this starting in 2025, thanks to Secure Act 2.0). Employers will start with a low contribution amount, such as 2% of an employee’s salary, and may even raise that amount by 1% annually up to a certain cap. In 2025, most employers will do this automatically, unless the employee opts out.
Now and in the future, you’re allowed to make adjustments to your participation level and investment choices within the 401(k) at any time once you’re enrolled, which can definitely be financially worth your while (see Step 5).
If your company has a waiting period before new hires are eligible to enroll, set a calendar reminder for the day you’re allowed past the velvet rope to make sure your paperwork goes through. Don’t give up even one extra moment to earn investment gains.
2. Choose an account type
Traditional 401(k)s are standard at workplaces, but more employers are adding the Roth 401(k) option, too.
As with Roth IRAs versus traditional IRAs, the main difference between the two types of plans is when you get your tax break:
The regular 401(k) offers it upfront since the money is automatically taken out of your paycheck before the IRS takes its cut (thus lowering your income tax bill for the year). You’ll pay income taxes down the road when you start making withdrawals in retirement.
Contributions to a Roth 401(k) are made with post-tax dollars (sorry, no upfront tax break), but qualified withdrawals are tax-free
Investment earnings within both types of 401(k)s are not taxed
Another upside to the Roth 401(k) is that, unlike a Roth IRA, there are no income restrictions to limit how much you can contribute. (Investors who are ineligible for a Roth IRA: Here’s your entree.)
The IRS allows you to stash savings in both a traditional 401(k) and Roth 401(k), which can add tax diversification to your portfolio, as long as you don’t exceed the annual maximum contribution limits of $22,500 in 2023 ($30,000 for those age 50 or older).
3. Review the investment choices
The 401(k) is simply a basket to hold your retirement savings. What you put into that basket (the specific investments) is up to you, within the limits of your plan. Most plans offer 10 to 20 mutual fund choices, each of which holds a diverse range of hundreds of investments, such as individual stocks, bonds and cash, that are chosen based on how closely they hew to a particular strategy (e.g., small growth companies) or market index, such asthe S&P 500 or the Nasdaq.
Here again, your company may choose a default investment option to get your money working for you right away. Most likely it will be a target-date mutual fund that contains a mix of investments that automatically rebalances, reducing risk the closer you get to retirement age. That’s a fine hands-off choice as long as you’re not overpaying for the convenience, which leads us to perhaps the most important task on your 401(k) to-do list ...
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4. Compare investment fees
Fees are the enemy of investment returns. If you review only one thing about your company retirement plan, make it investment fees (often called “management fees” or “expense ratios”) and steer clear of any mutual fund that charges more than 1%.
Participants have less control over plan administrative fees (paid to the financial company that runs the 401(k) plan), but employees should still see how much it is. Some employers cover this fee; others pass some or all of it on to employees based on the percentage of assets each worker has in their account.
5. Contribute enough to get any employer match
Even the priciest 401(k) plan can have some redeeming qualities. Free money — via an employer match — is one of them. Contributing enough money to get the match is the bare minimum level of participation to shoot for. Beyond that, it depends on the quality of the plan.
A standard employer match is 50% or 100% of your contributions, up to a limit, often 3% to 6% of your salary. Note that matching contributions may be subject to a vesting period, which means that leaving the company before matching contributions are vested means leaving that money behind. Any money you contribute to the plan will always be yours to keep.
If your company retirement plan offers a suitable array of low-cost investment choices and has low administrative fees, maxing out contributions in a 401(k) makes sense. It also ensures you get the most value out of the perks of tax-free investment growth and, depending on the type of account (traditional 401(k) or the Roth version), either upfront or back-end tax savings.
6. Supplement your savings outside of a 401(k)
The IRS is so keen on individuals saving for retirement that it’s willing to allow workers to save in multiple types of tax-favored accounts at once. Combining the powers of a 401(k) and an IRA can really supersize an individual’s tax savings and future financial freedom.
The ability to contribute to a Roth or traditional IRA is not just beneficial for workers stuck with a subpar 401(k). IRAs offer a lot more flexibility and control for all investors in terms of investment choices (limited only by what the broker offers), access to portfolio building and investment management tools, and control over account fees.
More 401(k) resources
This 401(k) calculator can help you figure out how much you should be saving
The NerdWallet IRA vs. 401(k) guide can help you maximize your retirement savings dollars in both types of accounts at once
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