Your 401k plan represents one leg of the three legged stool designed to help you save for retirement. The other two legs of that stool are your IRA and your Social Security benefits, but without the money in your 401k you might not have enough to retire and maintain your current lifestyle. If your employer offers a 401k plan, signing up and participating can help you prepare for retirement while reducing your current income taxes.
Review the 401k plan literature you receive when you start your job. Your employer should provide you with a packet of literature regarding the 401k plan, along with instructions on how to enroll. Many employers now use passive enrollment, in which new hires are automatically enrolled in the 401k plan unless they specifically opt out.
Check the plan literature and find out the amount of the company match. Invest at least enough in the plan to get the entire company match. The amount of matching funds and the formula for determining it varies from employer to employer, but a typical arrangement is for the company to kick in 50 cents on the dollar up to 6 percent of pay. That equates to 3 percent of your pay, so if you earn $40,000 a year you get an extra $1,200 just for enrolling in the plan.
Determine the optimal percentage to invest in the 401k plan. Keep in mind that the money you invest comes out of your paycheck before taxes, so your paycheck might not go down as much as you think. Some employers allow you to contribute up to 100 percent of your pay, although this is unrealistic for most workers. Others limit employee contributions to 15 to 20 percent. No matter what the setup of the plan, the contribution limit for 2010 is $16,500, with workers 50 years of age and older able to invest an extra $5,500 under the catch-up provision.
Sign up for the automatic escalation program if your employer offers one. Once you sign up, the percentage you contribute to the plan is raised by 1 percent a year until you reach the maximum set by the plan. This forces you to save more, and that higher savings level can help you build a bigger nest egg.
Compare the returns and costs of the mutual funds offered by the plan. The typical 401k plan includes a number of investment options, including aggressive stock funds, index stock funds, bond funds and stable value funds. The asset allocation you choose should be a function of your age, your tolerance for risk and the number of years you have until retirement. Younger workers with decades to go until retirement can afford to keep more in the stock market, while those nearing retirement might want to scale back their stock investments and keep more in fixed income investments.
Choose the funds you want to invest in, and then contact the administrator of the 401k and direct your investments to go into those funds. If you have online access to your 401k account you can move money around by logging on. Otherwise, call the administrator of the plan and direct the changes you wish to be made.
- Keep copies of your 401k statements in a safe place. Review the performance of your investments on a quarterly basis.
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