Your 401k is one of the best tools you have when it comes to saving for retirement. And like every financial tool, it’s most powerful when you know how to use it. Whether you’re thinking about opening a 401k for the first time or getting ready to make your first withdrawals, this guide will give you a sense of what you need to know.
How to Set Up a 401k
A 401k is a type of retirement savings account that is sponsored by your employer. Your company may offer something slightly different, like a 403(b), which is essentially the same thing. Either way, nearly all employer 401k accounts can be set up to invest a portion of your paycheck before taxes are taken out.
Some employers set up 401k accounts for their new employees automatically. Other companies require employees to take a few steps to set up the 401k themselves. If you’re not sure which way your company does things, simply ask your HR representative. Part of setting up your 401k is deciding how much of your income to contribute. That number can change depending on where you’re at in your career, so let’s break it down.
How Much Should I Have in my 401k?
As of 2018, the maximum amount any individual can contribute to their 401k is $18,500. If you’re over 50, you can make additional catch-up 401k contributions of $6,000 annually. As you’re setting up your 401k, always double-check to see if your company offers a match. In almost all cases, it’s best to contribute enough to maximize your employer’s match. Because if you don’t, you’re just leaving money on the table!
In Your 20s
Budding young professionals should start their 401k contributions as soon as possible. Even if you feel spread thin with student loan payments and other expenses, saving for retirement should always be one of your priorities. That’s because the sooner you invest, the longer your money has to grow. A good rule of thumb is to contribute the minimum needed to earn the maximum match from your employer or 5%, whichever is higher. In your 20s, you should be most concerned with making your retirement savings a habit and getting every penny from your employer that you possibly can.
In Your 30s
By your 30th birthday, you should have a 401k balance that’s equal to your yearly salary. It seems aggressive, but that’s because the longer your money has to grow, the bigger your balance will be by the time you retire. When you’re in your 30s, make your goal to increase your contributions by 1-2% each year. The idea is to increase your contributions at about the same rate as your annual raise. That way, you’ll save more without feeling pinched.
In Your 40s
By age 40, your 401k will have experienced 15-20 years of both growth and ongoing contributions. Your goal should be to have three times your annual salary saved by this time, since this account needs to keep growing for another 20 years. This is the point where most people have enough financial stability in their life to increase their contributions even further than before. This is a great place to make the push to contribute the maximum amount in order to maximize your money’s time for growth.
In Your 50s
The nature of work is changing dramatically. By age 50, you should have 5-6 times your annual salary saved for retirement. This is because you won’t be able to make any withdrawals until you’re nearly 60, but you’ll still need a strong cushion to support your long-term retirement needs if you decide to retire early, take a second act, or simply step down from a high-paying position for more work-life balance. If you’re not quite there yet, you’ll want to consider taking advantage of the catch-up payments that only folks over 50 are allowed to make.
Beyond Your 50s
If you continue to work into your 60s and beyond, good for you! Continue to contribute enough of your salary that you’re maximizing any match from your employer. You’re never too old to walk away from free money! Then, use a tool like Personal Capital to help you decide whether it’s best to continue 401k contributions or use a different investment vehicle, since your portfolio needs may have changed.
When Can I Withdraw from my 401k?
The whole point of investing in a 401k is to ensure you’ll have money to spend during your retirement. That’s why you’re not eligible to take any withdrawals until you turn 59 ½. If you do, you’ll pay a 10% penalty for early withdrawals, in addition to any taxes. You’re not required to start withdrawing from your 401k until you turn 70 ½. So most financial experts recommend waiting as long as possible before withdrawing so that your balance can continue to reap the rewards of compound interest.
What happens to my 401k if I leave my company?
Almost nobody keeps the same job forever. If you leave your company, never fear! Most companies allow you to rollover an old 401k to your new 401k within a certain timeframe. But if not, you can always roll over your eligible funds into an IRA. This advice also applies to freelancers or self-employed professionals. You don’t have to work in the corporate world to set yourself up for a smooth, happy retirement!
