A 401(k) plan is one of the most common types of employer-sponsored retirement savings plans in the United States. If your employer offers a 401(k), participating is an excellent way to save for retirement in a tax-advantaged manner and organize your personal finance. However, there are several important steps involved on how to set up your 401(k) account and choosing the right investment options. This guide will outline the setup process and factors to consider when getting started.
Enrolling in Your Plan
The first step is enrolling in your company’s 401(k) plan once you become eligible, which is usually within 3-6 months of starting your job. Talk to your employer’s benefits administrator to understand eligibility requirements and enrollment windows. You’ll typically need to complete some paperwork:
- Enrollment Form: Provide personal information, desired contribution amounts, and beneficiary designations.
- Investment Elections: Choose how to allocate contributions among the investment options available in your plan.
- Payroll Deductions: Authorization to deduct a portion of your salary on a pre-tax and/or Roth after-tax basis each pay period.
Most plans allow enrolling anytime after meeting eligibility, but some only offer windows quarterly or annually. Don’t miss your chance to start saving and earning potential employer-matching contributions.
Deciding How Much to Contribute
The next important step is determining how much of your salary to contribute to your 401(k) each pay period. The annual contribution limit is $20,500 in 2023, or $27,000 for those aged 50 or older. However, experts recommend if possible contributing at least 10-15% of your pre-tax income each year, including any employer match.
Calculate what percentage of your salary you can reasonably afford based on your budget and financial goals. Consider potential raises and automatic annual increases of 1% each year. You can always change your contribution amount if circumstances change. The earlier you start saving, the more your money can potentially grow through compound interest over many years.
Choosing Investment Options
Review the list of mutual funds, target date funds, stable value funds, stocks, bonds, or other investment choices offered by your 401(k) provider. Your goal is to construct an appropriately diversified portfolio based on your age, risk tolerance, and time horizon. This is important in personal finance.
Target date funds correlated to your estimated retirement year are a simple “set it and forget it” option. Or you can build your portfolio by allocating across different asset classes like large/small cap US stocks, international stocks, bonds, REITs, etc. Make sure any investment-related fees are reasonable.
Some plans provide online advisory tools or phone assistance to recommend suitable allocations. If you need help, take advantage of these free resources versus paying an outside advisor. Your investments should match your long-term strategy of growing retirement savings consistently over time.
Getting Matching Funds
Many employers match a portion of employee contributions as an additional benefit. Typical matches may be 50% of the first 6% contributed, for example. This is essentially free money you don’t want to leave on the table.
Contribute at least enough each pay period to receive the full employer match, even if that number is lower than the 10-15% personal contribution target. The match is one of the highest returns on investment you’ll find in a retirement plan when looking into your personal finance.
Managing Your Account
Review your 401(k) balance and asset allocation periodically, such as quarterly. Rebalance if any investment class deviates significantly from your target allocation. Consider increasing contributions annually to maximize savings opportunities.
You’ll need to designate or update beneficiaries in case something happens to you. Understand any loans, hardship withdrawals, or vesting schedules that may impact your employer contributions. Be aware of required minimum distributions once reaching age 72 as well.
Actively managing your account, even if minimally, ensures you’re on track for a comfortable retirement. Don’t neglect this important employee benefit providing tax-deferred growth to supplement other savings. With care and consistency, your 401(k) can become a substantial nest egg over the long run.
Rollovers and Job Changes
If leaving an employer, you have options regarding your 401(k) balance. You can cash out the account (risking penalties and taxes), keep it with the old provider in a new “rollover IRA,” or roll it into a new employer’s 401(k) if offered.
Rollovers allow retaining tax-deferred status and investment control versus a cashout. Rolling multiple small balances together can save fees over time too. This is a major decision impacting your retirement, so seek professional guidance if uncertain. Proper planning ensures your savings stay on track during job or career changes.
Financial knowledge is important and constantly learning is the way to go. With that said you should start learning personal finance today.
