How to start a 401(k) and start saving this week [for employees]

A 401(k) is the basis of many Americans’ retirement strategies, and it’s the most popular retirement account by far. In 2021, almost two-thirds of private-industry workers (63%) had access to a defined-contribution plan, including 401(k)s.

If you’re ready to get serious about your retirement planning, a 401(k) is one of the easiest ways to begin. But how do you start a 401(k)?

These accounts are always tied to your employer (unless you’re self- employed) so chat with your HR department or boss to understand what options might be available. Some employers have waiting periods, so you won’t be able to contribute until you’ve been in your role for a period of time. 

You’ll still need to know what you’re getting into to make smart investment decisions, so follow our step-by-step guide to opening your 401(k) below. 

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1. Decide how your 401(k) fits in your overall retirement strategy

Before you learn how to open a 401(k), you should understand how it fits into your plan. A 401(k) is likely just a piece of your retirement planning puzzle. It’s a big, very important piece, but it’s not the only tax-advantaged account available for your strategy. 

It can also have a direct impact on other potential tax benefits related to saving for retirement. For example, contributing to a 401(k) may disqualify your traditional IRA contributions from being tax-deductible.

People typically prioritize their 401(k) (especially if they have employer-match benefits), but you should understand how all of your retirement plans work together to optimize your tax advantages across accounts. 

As you evaluate your existing accounts and strategy, consider:

• Tax advantage diversification: Some people might go all in on Roth if they anticipate higher future earnings or traditional accounts if they need an immediate tax break, but many investors benefit from both accounts. 
• Investment diversification: You choose your 401(k) investments from a pool of employer selections, but an IRA gives you free rein to choose your provider and investments based on your needs. 
• Contribution limits: IRAs and 401(k)s have separate contribution limits, and while 401(k) limits are higher, you can contribute to both account types.
• Account access: Life happens, and you may need access to your assets. A 401(k) sometimes offers 401(k) loans, while Roth IRAs allow penalty-free withdrawals on contributions. Opening a few accounts provides flexibility without jeopardizing your entire retirement. 

2. Enroll in your workplace plan

Your very first step is to enroll in a 401(k) via your employer. Your manager, HR representative, or plan provider will walk you through the details and help you understand your investment options, but it helps to have a baseline understanding of 401(k)s and their advantages.

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Some employers begin enrollment on day one or even auto-enroll employees in the company 401(k), so you might already be enrolled. 

But can you enroll in a 401(k) at any time? You can open a Solo 401(k) any time before December 31, while employer-provided plans offer set enrollment periods one to four times a year. Talk with your employer to figure out when enrollment kicks off. 

At enrollment, you’ll choose an account type (Roth or traditional), investment funds, and your deferral rate, which is how much you contribute from each paycheck. You can change your deferral rate  and investments later, but you should already know if you want a Roth or traditional account. 

• Traditional 401(k)s are tax-deferred accounts funded with pre-tax contributions, so you pay less taxes today and delay the tax bill until you withdraw from your 401(k) balance. 
• Roth 401(k)s are tax-deferred too,  but since the account is funded with after-tax contributions, you don’t owe any taxes when you withdraw your contributions at any time or when you withdraw your earnings after age 59 1/2. 

If you were auto-enrolled in a company 401(k), you likely have a traditional account and pre-set deferral rate and investment fund. Look this over and make sure everything aligns with your retirement goals and current budget. 

The best fit depends on your current income and retirement goals. 

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If you expect to increase your income, choose a Roth account and pay taxes now. If you’re at your peak earning potential, defer your taxes until retirement when you’ll likely have a lower rate. 

Don’t worry if you’re not sure what to look for – we’ll walk you through it. 

3. Compare and select your investment options

Employer-provided 401(k)s offer a pool of investment options, including funds that are a mix of stocks and bonds.

Some employers choose a default plan to kickstart your 401(k), but you can adjust your portfolio as you see fit. Your investments should be based on your risk tolerance, time horizon, and growth goals. 

You typically adjust to more conservative allocations as you age toward retirement to avoid risking your savings when you have less time to recover. 

Aggressive allocations are best suited for a secondary retirement account where you can take bigger risks with your investments without sacrificing your entire retirement savings. 

This provides potential for higher returns but also for large losses if stocks take a dive. If you want to play the market, start when you’re young and have decades to repair your retirement account before you need it. 

401(k) investment mixes are often categorized as conservative, moderate, or aggressive based on your asset allocation. 

Index funds and target date funds are particularly popular all-in-one funds with a mix of asset types. Index funds focus on growth and often contain more stocks than bonds. Meanwhile, target date funds are goal-oriented based on your age. So a 2065 target date funds uses the 2065 retirement deadline to determine risk. 

The specific allocations and definitions vary among experts, but here’s a general breakdown:

Tax-advantaged retirement accounts are long-term assets designed to grow over decades. Historically, they rebound from short-term volatility and losses within a few years, so you don’t want to be too conservative with your investments. 

Instead, pay attention to your asset allocation. For example, if one of your stocks is underperforming but your moderate portfolio is still intact, you’re good to go. The stock performance is likely to rebound on its own. 

If all of your stocks are performing really well but your stock allocation has ballooned to 75% instead of 60%, you should consider rebalancing your portfolio to a moderate growth track. 

Why rebalance if you’re making money off those stocks? 

Because — though they’re performing well now — a 75% allocation is extremely risky. If a couple of stocks take a plunge and most of your 401(k) wealth is wrapped up in stocks, your retirement takes a hit. 

Tracking and understanding your asset performance and allocations can be tricky if you’re a new investor. Chat with a pro for guidance — especially if you’re interested in a more aggressive allocation. 

3. Understand your 401(k) fees

A 401(k) isn’t free, and it’s easy to overlook the costs wrapped up in your account. Fees come with all kinds of names:

• Administrative fees: The plan provider charges these for day-to-day operations and services. Often it’s a direct fee paid by your employer or charged against your plan assets. 
• Expense ratio: Often the most expensive fee, this includes shareholder and operating expense fees, and you’ll typically pay it from your investment returns.
• Individual service fees: Expenses tied to a specific account transaction, like a 401(k) loan or IRA rollover, that are charged directly. 

Fees are paid directly or indirectly, depending on the fee and plan provider. Investment fees and many administrative fees are paid directly and deducted from your 401(k) account. Disclosures and reports will explicitly note these.  

Indirect fees are tied to the investment cost and lower your returns. These aren’t as transparent and are sometimes referred to as “hidden” 401(k) fees. 

While you can’t avoid most administrative fees since your employer chooses the plan provider, you can choose your investments after considering expense ratios and other costs associated with specific funds.

Consult your human resources team or plan provider if you need help understanding different plan fees and options.  

4. Choose your contribution amount

How much you should contribute to a 401(k) depends entirely on your personal budget and retirement goals. 

If you can’t afford to max out your 401(k), there’s no need to stress about it. 

On the other hand, you’ll need pretty large contributions if you want to retire early. 

It’s tough to decide where to start, but we can help. 

‍First, match any employer contributions offered. Many employers will match a certain percentage of your contributions up to a specific amount of your salary. 

For example, your job matches 50% of your contributions, up to 4% of your salary. Let’s say you earn $100,000 a year and contribute $4,000 to your 401(k) — your job will add $2,000 to the balance. 

After that, you can continue 401(k) contributions until you max out the $23,000 limit or choose to contribute to an IRA. And you can always adjust your contributions as your goals change. 

An IRA offers more investment options than an employer-provided account and can still earn tax deductions. The contribution limits are lower at $7,000 in 2024, plus $1,000 if you’re over age 50, but there are ways to get around that, such as with a mega backdoor Roth IRA, if you’re really committed to saving. 

A Roth IRA is a good option if you want tax-free growth and flexible access to your account contributions. It has the same contribution limits as a traditional IRA, but high-income earners might not qualify for direct contributions. 

The median American contributed 6.4% of their salary to a 401(k) in 2022. Consider increasing your investments if you want to retire early or prepare for an extra cushy lifestyle.

Retirement options without an employer

If your employer doesn’t offer a 401(k) plan, you’re not out of luck. If you have a side hustle or small business without full-time employees, you may qualify for a solo 401(k). 

These work almost exactly like a standard 401(k), except you’re both the employer and the employee. That means you can make employer contributions and elective deferrals — and enjoy tax deductions for both amounts. 

401(k)s also aren’t the only tax-advantaged account available. There are several types of individual retirement accounts (IRAs) to choose from, including:

• Traditional IRA: an individual account funded with pre-tax contributions.
• Roth IRA: an individual account funded with after-tax contributions.
• SEP IRA: an employer-provided IRA that accepts contributions of up to $69,000.
• SIMPLE IRA: an IRA option for small employers accepts up to $16,000 in contributions or $19,500 for employees 50 and older. .

IRAs beat 401(k)s in a few categories:

• Individually owned means you have the account regardless of your employer. You don’t have to stop contributions or roll over the account when you switch jobs. 
• Since you choose the IRA plan provider and investment options from scratch, you have a much wider investment selection than the typical employer-provided 401(k).
  

These are excellent opportunities to diversify your retirement strategy, but a 401(k) is still extremely valuable if you’re eligible to set one up. 

The Playbook take: Enroll in your 401(k) ASAP

A 401(k) is many people’s first step to financial freedom, and it’s an important account to maintain for almost any investor. It’s relatively easy to start a 401(k) if you’re eligible, plus there are plenty of resources to help you along the way. 

Ready to take retirement by the reins? Playbook can help you explore your tax-advantaged options and start a solid tax strategy so you keep more of your money.