In the days of yesteryear, companies used to offer their employees pensions. A pension is essentially a guaranteed income after retirement. Most companies today have let go of their pension programs in favor of a 401(k).
These are tax-advantaged accounts that allow individuals to have more control over their retirement savings. A 401(k) is one of your best options for preparing for a bright, relaxing retirement. You might be wondering how to set up a 401k? Keep reading!
Am I eligible for a 401(k)?
Before we really get into how to set up a 401k, it’s important to understand if you’re even eligible. Many companies offer a 401(k) to their employees. You may not need to be a full-time employee to get access to a 401(k) through your employer. Check with your company’s human resources department for details about your individual company’s guidelines.
Even if your employer doesn’t make any contributions, you should set up a 401(k) if you can. And if your employer does make contributions, then don’t wait another second. Missing out on a 401(k) match from your employer means you’re passing up free money. Think of a match as an automatic bonus from your company that just ends up in your retirement account.
Should I open a 401(k) if I have student loans?
Start saving for retirement as early as possible in order to harness the power of compound interest. You shouldn’t wait until you pay off your loans to start saving – that’s up to 10 years (or more!) of savings you’ll miss out on! Even if you’re not making a lot of money, tucking away a small amount of your paycheck into a 401(k) can really add up. Try to commit 5% of your gross salary yearly, and then add a percent or two each year. If you earn a big promotion then that’s a great time to contribute even more.
Types of 401(k)s: Roth and Traditional
When you first set up your 401(k), you might be offered the option of a Roth or a traditional account. The difference between the two is how they are taxed. With a traditional 401(k), your investments are not taxed when you make them, instead, they are taxed upon withdrawal. With a Roth 401(k), the amount you invest is taxed as income, but your withdrawals are then tax-free.
So is it better to be taxed when you invest, or when you withdraw? The answer depends on your individual situation. If you are in a lower tax bracket now than you expect to be later on in life, choose the Roth option. If you could benefit from pre-tax investments and expect to be in a lower tax bracket after you retire, the traditional option is likely best. The good news is that most 401(k) providers will let you open both kinds – so you can adjust over time if you need to.
Diversify, Diversify, Diversify!
One of the most powerful ways to minimize your investment risks is to diversify. Most 401(k) providers give an easy setup option that puts your money into a target date fund that’s determined by when you’ll turn 65 – the traditional retirement age. So if you’ll turn 65 in 2057, your provider may default your investment into a 2055 or 2060 Target Date Fund. These are pre-packaged ways to ensure you get an ongoing balance of stocks, bonds, and cash that fits your long-term retirement needs.
But beware – target date funds may not be the best choice for you. Closely review the fees and expenses associated with any funds offered by your provider. There might be ways for you to get the same diversified mix of investments you need for a lower cost. Confused or overwhelmed? That’s OK. Start with a target date fund, and then use a service like Blooom to help you optimize and rebalance over time.
Also Read: Blooom Review – Receive a Free 401k Analysis
What about company stock?
If your company offers a stock purchase program for employees, that will likely be administered through your 401(k) provider. It can be a great way for you to get high-quality stock at a discount; some companies offer as much as a 15% discount on company stock for their employees!
However, to minimize your risk, you should also minimize your ratio of company stock to the rest of your retirement savings. Experts recommend that no more than 5% of your total retirement assets should be invested in a single company stock.
What if I change jobs?
Some folks make the mistake of not investing at all because they plan on changing jobs. What they don’t know is that you don’t lose what you’ve invested in your 401(k), even when you’re changing companies. Invest now, and if you change later, simply do a roll-over to your new 401(k) account with your new company.
Some employers require you to remain with the company for a defined number of years before you can keep any match contributions (referred to as “vesting”). Even if you’re not fully vested, transferring what you can to your new 401(k) can help you stay on-track with your retirement goals no matter where your career takes you.
