How to Set Up Your 401(k)

February 17th, 2019

You start a new job. And amidst the rapid fire handshakes and introductions, someone hands you a hefty packet of new hire information, including your benefits. Somewhere in there is the information about your 401(k), a type of retirement account offered through your employer.
Sounds great, you say, but I’m here to work. I’ll worry about that later.
Not so fast! You could be missing out on some serious money.

Why set up a 401(k)?

A 401(k) can be a great way to start investing for two important reasons;
1) It offers a tax-advantage, which means your money will grow faster than it otherwise would in a more general taxable investment account.
2) Some employers offer a match, meaning they’ll contribute money in addition to what you contribute. Who doesn’t like free money?
Both of these reasons can make a 401(k) an attractive place to invest your money. But you do need to sign up to take advantage. Here’s what you do.

1. Get started by signing up

You should be given information on how to sign up when you first start at your new job. But you can also talk to someone in human resources if you need help.
Typically, you’ll be directed to an online portal where you can access your various benefits, which will include your 401(k).
We should mention that some employers will automatically enroll you in a 401(k) plan to encourage you to start investing sooner. But you aren’t off the hook. The default contribution amounts and investment choices may not be quite what you want (they tend to set low contribution rates and choose fairly conservative investments). So you’ll still want to sign in and consider making changes to the default settings. We’ll get to those details shortly.
Also, some employers will have a waiting period before new hires are able to enroll. If that’s the case, mark your calendar and sign up as soon as you become eligible.

2. Choose the type of account you want

When you sign up, you might have a choice between a few different types of accounts. The standard type is called a traditional 401(k) (not too surprisingly). But some employers now offer something called a Roth 401(k) too. The difference is in how the tax benefit works.
With a traditional 401(k), your taxes are deferred. This means you contribute pre-tax money directly from your paycheck to the account. And then your money is allowed to grow tax-free until you take it out in retirement. At that point, you will have to pay income taxes.
With a Roth 401(k), you pay income taxes now. But your contributions are then allowed to grow tax-free and won’t be taxed when you take your money out.
So it’s about taxes now vs. taxes later. If you think you’ll be in a higher tax bracket when you retire, a Roth can be a good idea. If you think you’ll be in a lower tax bracket, a traditional might make more sense. And if you aren’t quite sure, you can consider putting some money in each. There are also traditional and Roth IRAs, which you would set up outside of work.

3. Decide on a contribution amount

It can be a little tricky to decide just how much of your paycheck you want to contribute to your 401(k). After all, you need to balance living today with saving for the future.
In general, it’s a good idea to contribute at least enough to get the full employer match.
The exact matching formula can vary from one employer to the next, but often they’ll contribute a set percentage, between 50% and 100% of what you contribute, up to a certain amount, say 3% to 6% of your total pay.
Your match is basically like free money once it has vested.
The vesting schedule tells you what percentage of the matched money you would keep if you left your employer (it usually takes a few years to be fully vested). But you would keep all of the money you personally contribute, regardless of the vesting schedule.
And you don’t need to stop just because you hit the full match. You’re able to contribute up to the annual contribution limits set by the IRS, which currently stand at $19,500 for 2020 and 2021.

4. Select your investments

Your 401(k) is not an investment itself, it’s just an account for holding investments. Typically, most 401(k) plans offer about a dozen to two dozen different investment funds to choose from. When you invest in funds, your money will be spread out across dozens or even hundreds of investments, reducing your risk. And these investments will range from stocks, to bonds, to cash.
As you compare your investment choices, pay attention to the management fees (or the expense ratios), which will vary from fund to fund and from one 401(k) plan to another.
Some 401(k) plans negotiate lower fees than you would get if you invested on your own in an IRA or taxable brokerage account. But some don’t. If you’re paying more than 0.5% in annual management fees, you’re probably better off sticking with lower cost index funds.
Your employer might also offer a default investment selection with something called a target date fund, which will automatically select and manage investments for you based on your age, reducing the risk as you approach retirement. While this can be a good choice for low hassle investing, these funds tend to charge higher fees, making them less attractive.
Learn More: If you want to learn more about how to start investing, we have you covered.

5. Keep at it

A great thing about having a 401(k) is that you’ll be making automatic contributions to your retirement savings without having to lift a finger. You may even be able to set up automatic increases for your account. So your contribution percentage will increase over time, getting you to save even more down the road. You might be surprised at how much you can actually put away.
And your 401(k) isn’t the end of the story when it comes to investing.
You could also consider setting up an IRA outside of work, which also offers a tax benefit (but won’t have a match), or setting up a taxable investment account with a brokerage or robo-advisor. These won’t offer any tax benefits, but they offer more flexibility – you can take your money out anytime and don’t have to wait until retirement. With a 401(k), your money is tied up until retirement for the most part.
And it doesn’t necessarily need to be all or nothing either. For example, you could invest in your 401(k) to get the full match, contribute some money to an IRA, and put some in a brokerage account or robo-advisor for nearer-term needs. But no matter which type of accounts you choose, you’ll want to periodically review your investments to make sure you’re still on the right track and your investment choices makes sense.


Setting up your 401(k) can be a great way to start investing because your contributions are automated, it offers a tax benefit, and your employer may even match a portion of your contributions.
The sooner you sign up and get started, the faster your investments will grow. And the more confident you can feel about retiring comfortably when the time comes. So what are you waiting for? Go sign up for that 401(k)!

Anything else we can help you with?

► How to roll over a 401(k) to an IRA

► Learn more about brokerage accounts and robo-advisors

► Learn how to refinance your student loans

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