How to set up your 401(k)

A 401(k) is an employer-sponsored retirement plan that allows workers to put money aside on a special tax-advantaged basis, helping them save for their golden years more quickly. Most 401(k) plans are offered to employees when they begin a new job or after a certain holding period, such as 30 days after a worker’s first day. The process of how to enroll in a 401(k) depends on the company: Some firms automatically enroll their employees while others require employees to complete the process themselves.

Here’s how to set up your 401(k) and what to watch out for.

1. Get enrolled

Some employers automatically enroll employees into their 401(k) at a predetermined percentage of their salary. Others will leave the onus on new employees to enroll themselves either immediately after starting to work or after an initial waiting period.

The good news is that you can enroll in a 401(k) year-round, and contributions are flexible. This means you can increase, lower, or pause your contributions to the account any time you wish.

Use your company’s benefits platform or contact your human resources representative, to find out who your 401(k) provider is. From there, you can find out if you have already been enrolled, or you can enroll yourself if you’re not.

2. Set a contribution amount you’re comfortable with

The annual 401(k) contribution limit for 2024 is $23,000, so the percentage of your salary that is needed to reach the limit depends on how much you make.

If you can’t contribute the maximum, you can start with any amount. The most important thing to do is to keep regularly investing from each paycheck, regardless of the amount. You can always increase your contributions as you go along. In fact, some 401(k) plans can be set to increase your contribution automatically each year.

3. Maximize your employer’s 401(k) match

As you’re considering how much to contribute to your 401(k), it’s important to know that some employers will match their employee’s contributions up to a certain amount, sometimes 3 to 5 percent of an employee’s salary. That’s free money and you should take advantage, if you can.

Some plans require a vesting period before employees fully own a company match, often for a few years. Vesting schedules vary by company, but they mean that if you leave your job before the vesting period, you may be able to keep only a portion of the employer match. Your own contributions, though, are always fully vested and available to you.

After fully meeting your company’s vesting schedule, you’ll have 100 percent ownership of any matching contributions as well as all future matching matches.

4. Choose between traditional and Roth options

A 401(k) has two major types, depending on their specific tax advantage: a traditional 401(k) or a Roth 401(k).

• A traditional 401(k) allows you to make contributions on a pre-tax basis, meaning you don’t owe taxes on your contribution. Then your money can grow tax-deferred and is taxed only when you begin taking distributions.
• A Roth 401(k) allows you to make contributions on an after-tax basis, meaning you won’t get a tax break on your contribution. However, the contribution grows tax-free and withdrawals are tax-free during retirement, starting at age 59½ .

Each type comes with some advantages, so it’s useful to consider which is best for your needs. In a traditional 401(k), contributions lower your taxable income today, but you are deferring your tax responsibility to some time in the future and will pay an unknown tax rate. With a Roth, you have the advantage of tax-free withdrawals, but will not enjoy upfront tax savings.

You can contribute money to both plans as long as you do not exceed the annual limit on contributions across all accounts. So you can take advantage of what both accounts can offer.

5. Choose your investments wisely

Although your employer sponsors the 401(k) plan, you maintain all responsibility for the account’s investments, including whether you want someone else to manage it.

If you’re investing the account yourself, you’ll choosefrom the plan’s available funds and set up how the 401(k) is allocated.

Most 401(k) plans have at least three investment choices when it comes to asset allocation, though others offer many more options. The average 401(k) plan offers about 13 investment options, according to the Investment Company Institute.

Choices can include a mix of investments including: mutual funds, company stock and index funds, as well as stable value funds, bond funds and “target-date” funds, which reduce the risk level associated with your portfolio as you near retirement.

Some plans let you buy other investments, such as individual stocks and bonds, guaranteed investment contracts, company stock and variable annuities.

For each potential investment, investors can access prospectuses that detail relevant information about each fund. Investors will have access to fund performance and costs, which are crucial in determining if an investment is right for you.

Stock funds have tended to perform better than bond funds over long periods, though they’re riskier in the short term because of their volatility. Some experts advise investors with decades or more until retirement to invest heavily in a diversified portfolio of stocks or stock funds.

Bankrate’s 401 (k) calculator can help you visualize how the retirement contributions from your paycheck affect your nest egg over time.

6. Take fees into consideration

Mutual funds charge investment fees that can eat into returns, so you’ll need to take these into consideration when choosing the right funds for you. These fees are detailed in the fund’s prospectus. Typically, mutual funds charge an expense ratio, which is a fee based on the amount you have invested in the fund. But funds may charge other fees, too.

It’s important to consider the fee as it relates to the investment performance. Fees for stock and bond mutual funds can range widely, from cheap (less than 0.15 percent annually) to expensive (more than 1 percent annually). In practical terms, those fees would cost $15 annually for every $10,000 invested up to $100 or more. Fees for target-date funds tend to be on the higher side, as are fees for annuities. Stock funds tend to deliver some of the best long-term returns and are available at a low cost through index funds.

If you have someone manage your investments for you, you’ll generally pay a higher investment fee than in a target-date fund or if you manage the account  yourself.

Bottom line

When it comes to setting up your 401(k), know that saving for retirement is a long-term game. Take the time to consider what your individual time horizon and risk tolerance are when it comes to your retirement investments. It’s also not a bad idea to check in on your account from time to time once you get it set up to ensure it’s performing as expected.

— Bankrate’s Logan Moore contributed to an update of this story.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.