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How to Start a 401(k) and Save For Retirement

laurenbrown
Lauren Brown Updated: June 27, 2023 • 7 min read
senior woman researching retirement

One of the most common ways to save for retirement is through a 401(k). A 401(k) is an employer-sponsored retirement plan that allows you to save a portion of your paycheck to invest. Thanks to advantages such as employer matching contributions and tax deferral, it is an effective tool for building your nest egg. To maximize the plan's financial benefits, consider enrolling in your employer’s 401(k) plan sooner rather than later. 

Thanks to advantages such as employer matching contributions and tax deferral, a 401(k) an effective tool for building your nest egg.

How to Start a 401(k)

You may feel overwhelmed wondering how to start 401(k) savings. In reality, 401(k) set up involves only a few straightforward steps. 

How to set up a 401(k) for employees:

  • Determine eligibility: The first step is to verify your eligibility for your company's 401(k) plan. Some businesses allow employees to start contributing immediately, while others may require a certain period of employment first. Your company’s human resources department can provide this information for you.
  • Choose the account type: If applicable, you may also need to choose the 401(k) plan type. Most employers have traditional 401(k)s though some also provide a Roth 401(k) option. With a traditional 401(k), your contributions are made with pre-tax dollars, while withdrawals in retirement are taxed. A Roth 401(k) is funded with post-tax dollars, allowing for tax-free withdrawals in retirement. The choice between the two impacts the timing of your tax liability.
  • Select your contribution amount: As you consider how to start 401(k) savings, one of the essential aspects is deciding what percentage of your salary you want to contribute. Because the program is tax-advantaged, the government limits how much you can contribute to the plan annually. For 2023, the contribution limit is $22,500. Even if you can not contribute the maximum allowed, remember that every little bit helps. With time, your money can grow significantly due to compounding.
  • Understand your employer's match: If your employer offers matching, they will contribute to your 401(k) based on your contribution amounts. Typically, companies cap matching at a certain percentage of your salary. If possible, consider maximizing your savings to receive the full employer match, which is essentially free money for your retirement. 
  • Select your investments: When you start your 401(k), you must also choose where to invest your contributions. Most 401(k)s offer various investment options, including stocks, bonds, mutual and target-date funds. When deciding between them, it is important to consider your retirement goals, risk tolerance, and time horizon.
  • Regularly review and adjust: After completing your 401(k) set up, consider reviewing your account regularly to ensure you are on track toward your retirement goal. You can adjust your contribution level, perhaps increasing it as your salary increases. You can also change your investments as your time horizon or risk tolerance changes. 

Starting a 401(k) begins an ongoing process of saving and investing for your future. Making well-informed decisions now can substantially impact your financial well-being in retirement.

For 2023, the 401(k) contribution limit is $22,500.

Benefits of a 401(k)

The 401(k) plan is a popular choice for retirement savings due to several unique features:

  • Automated savings: One of the benefits of an employer-sponsored program is that the company can divert a predetermined portion of your paycheck into your 401(k). Not only will automated contributions simplify the savings process, but they can add up to a sizable amount over time. 
  • Employer matching: A standout feature of 401(k)s is company matching, where your employer matches a portion of your contribution up to a set limit. By taking advantage of this and maximizing the amount received from your employer, you can put additional money into your retirement fund. 
  • Pre-tax contributions: With a traditional 401(k), you can contribute with pre-tax dollars. This can help to reduce your taxable income for the year, potentially decreasing your current tax liability.
  • Tax-advantaged growth: You will not pay annual taxes on your 401(k) account. With a traditional 401(k), the growth is tax-deferred, meaning you will pay taxes on your investment gains once you withdraw the funds. With a Roth, you fund the account with after-tax dollars, which allows your withdrawals to be tax-free. Regardless of the account type, the tax advantage potentially allows for faster growth since your entire investment balance remains in the account and compounds over time.

These benefits are why many people regard the 401(k) as a key aspect of their retirement planning. 

Making well-informed decisions now can substantially impact your financial well-being in retirement.

How to Compare 401(k) Plans

Not all 401(k)s are created equal, so understanding the specifics can significantly impact your retirement savings. Below are a few considerations when comparing 401(k) plans:

  • Compare fees: Fees are among the most critical factors, as they can affect your investment returns. One charge to evaluate is the cost associated with your fund, called the investment fee or management fee. These fees typically range from 0.15% to over 1%. Not all investments have the same fees, so if yours are high, it could cost you thousands of dollars over time. Another cost to note is the administration fee charged by the financial institution that runs the plan.
  • Consider your investment goals: Your retirement goals will be crucial in choosing the right plan. If your goal is to retire early, for example, you may need to look for a 401(k) offering a broader range of investment options so you can select assets that could generate a better return. However, the possibility of higher growth often comes with greater risks.
  • Determine your risk tolerance: As you consider how to start 401(k) savings, assessing your ability and willingness to take on risk is crucial. For example, a plan with a broad selection of bond funds or target-date funds could be appealing if you have a lower risk tolerance.
  • Review your plan regularly: Your financial situation, goals, and market conditions can all change over time. Regular reviews of your 401(k) plan, perhaps annually or semi-annually, can help you make necessary adjustments to keep your retirement strategy on track.

Your 401(k) is a long-term investment, and choosing the right plan requires careful consideration. If needed, you can also seek advice and further guidance from a financial advisor. 

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When Should You Start a 401(k)?

Once you have answered the "401(k) how to start" question, you might still be left wondering, “when should you start a 401(k)?” The sooner, the better. Starting a 401(k) early in life can significantly boost your retirement savings because of the power of compounding.

Let's look at an example to illustrate this point: Amy, who starts a 401(k) at age 25, and Bailey, who waits until they are 45 to begin saving. Amy contributes $200 each month from 25 until retirement at age 65, while Bailey contributes $400 monthly from 45 to 65. Who ends up with a larger retirement fund if they both earn an average annual return of 7%? 

Although Amy and Bailey contribute the same overall amount of $96,000, Amy has significantly more in retirement. At age 65, Amy would have nearly $525,000, while Bailey would have just over $200,000. Why? Because Amy's money had more time to grow, thanks to compounding.

Starting your savings early is not just about putting more money aside but giving your money more time to grow.

Golden Tips for 401(k) Success

Completing 401(k) set up is just the beginning of your journey to a successful retirement. To further advance your savings and financial stability, consider the following:

  • Seek professional advice: Consider seeking advice from a financial planner who can provide personalized advice based on your financial situation. Professional guidance can often help steer your investment decisions in the right direction and keep you on track with your retirement savings goals. 
  • Use your employee benefits: Besides setting up your 401(k), educate yourself on other benefits you might be eligible for. You may have access to pensions, medical coverage, or insurance coverage. Using your employee benefits to their fullest can boost your overall financial well-being. 
  • Utilize additional retirement savings options: Consider a supplement savings plan in addition to your 401(k). For example, an Individual Retirement Account (IRA) can offer different tax advantages and benefit your savings strategy. You can also save outside traditional retirement accounts to further build your nest egg. 
  • Staying updated with changing retirement laws and regulations: Over time, government laws and regulations can change, impacting your savings plan and the tax benefits you receive. Keeping informed allows you to adjust your strategy to maximize your savings. 

Successfully funding your retirement may involve more than just starting a 401(k). With these tips, you can navigate your savings confidently.

Starting your savings early is not just about putting more money aside but giving your money more time to grow.

 

 

Conclusion

Beginning your journey toward retirement with a 401(k) can be a beneficial step toward financial stability. A 401(k) allows you to benefit from automated savings, tax advantages, and, in many cases, employer matching contributions akin to free money. Once you determine how to set up a 401(k) for employees, consider reviewing your plan regularly to ensure you are on the right track. 

The advantage of starting a 401(k) early in life are substantial. The power of compounding can significantly enhance your savings if you start at age 25, for example, instead of 45. Saving in a 401(k) is not just about preparing for retirement; it is about investing in your future to one day realize your retirement dream. 

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FAQ

Can I start a 401(k) on my own?

You can initiate a 401(k) set up on your own, albeit indirectly, as the 401(k) is an employer-sponsored retirement plan. As an employee, you can encourage your employer to set up a 401(k) if one is not already in place.

What percentage should I start my 401(k)?

Determining your 401(k) contribution percentage involves assessing your finances and goals. Financial advisors often suggest allocating 10% to 15% of your pre-tax income toward your 401(k) and other long-term savings. If this seems too much, consider starting lower and gradually increasing over time. If your employer matches contributions, consider contributing at least enough to maximize their matching.

What happens to your 401(k) when you quit?

Upon leaving a job, the funds in your 401(k) remain yours. You have several options after you quit, including leaving the funds in the old employer's 401(k) or rolling them over into a new employer's plan. You can also roll the previous 401(k) into an IRA or take a distribution in the form of a withdrawal. Individuals under age 55 are subject to a 10% withdrawal penalty, though, and there are likely other tax implications to consider if you withdraw the funds.

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laurenbrown
Written by Lauren Brown linkedin-icon

Lauren has over a decade of experience in wealth management and financial planning. She is a CFA charterholder and holds a Bachelor's degree in Finance. Lauren has worked with several asset management firms, offering wealth advisory and portfolio management services to high-net-worth clients.