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How to Invest in a 401(k): Easy Steps to Take

A 401(k) plan aims to help you invest a percent of your paycheck. In 2024, you're currently allowed to contribute up to $23,500 to a 401(k) or up to $30,500 if you're 50 or older.

You can open a 401(k) for tax-advantaged retirement savings, but you’ll have to qualify by working with a company that offers them. 401(k)s can be an essential part of your retirement planning

What is a 401(k)?

A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a portion of their paycheck before taxes. These contributions and any earnings from the 401(k) are not taxed until withdrawn.

401k of the IRS‘s Internal Revenue Code authorized the use of a defined contribution plan that allows the employee to make pre-tax contributions to a retirement savings plan.

How does a 401(k) plan work?

Under 401(k) plans, also commonly known as defined contribution plans, you can save money toward your retirement on a tax-deferred basis.

A defined contribution plan is a retirement plan in which the employer, employee, or both make regular contributions. With a 401(k), you don’t pay federal or state income taxes on your savings or investment earnings until you withdraw the money at retirement.

With 401(k) plans, you decide how much to save, up to the IRS’s contribution limit, and choose the investments based on your plan. A retirement plan administrator is contracted by your employer and manages the 401(k) plan participants.

When you leave your job, you still maintain ownership over your account.

Why 401(k)s?

A 401(k) plan aims to help you invest a percent of your paycheck. In 2024, you’re currently allowed to contribute up to $23,500 to a 401(k) or up to $30,500 if you’re 50 or older.

401(k)s have pre-tax advantages. Your contributions reduce your taxable income each year, and you’ll be required to pay taxes on your distributions in retirement. The idea is that you may be in a lower tax bracket in retirement and, therefore, pay lower taxes.

Some employers offer Roth 401(k)s, where your contributions are after-tax. Unlike traditional 401(k)s, Roth 401(k)s give you tax-free withdrawals in retirement.

How can you open a 401(k)?

You must be employed by a company that offers a Defined Contribution Plan such as a 401(k). 

Many employers offer a 401(k) plan as part of their employee benefits package. When you start a new job, you can enroll in your company’s 401(k) Plan, or you can sign up during open enrollment for existing employees.

As a new employee, you have the opportunity to enroll during the first 30-60 days of employment. If you don’t sign up during that period, you’ll need to wait for the annual open enrollment period to join the Plan. Enrollment periods vary from company to company, so make sure you speak with your Human Resource Manager for specific dates.

Talk to the HR Department about the 401(k) Plan Benefits

Ask your manager or Human Resources Department about a 401(k) plan and the open enrollment dates.

  1. Determine if you’re eligible to enroll.
  2. Ask about the specifics of the Plan and information on the Plan Administrator
  3. Learn about any employer matching contributions and vesting period.
  4. Use the free financial advice offered by the Plan Administrator.

If you’re starting a new job, you’ll have the opportunity to enroll immediately. The sooner you start contributing to your company’s 401(k) plan the better chance to reach retirement goals.

Get the Most from your 401(k)

  1. Contribute as much as you can up to the contribution limits set by the IRS.
  2. Many employers match contributions up to a certain percentage of your salary. So, if you can’t contribute the max, at the very least, contribute the amount your employer will match. Or else you’re throwing away money that belongs to you.

What is Employer Matching?

An employer matching contribution is an employer-sponsored retirement plan benefit in which an employer matches a portion of an employee’s contributions to their retirement account, typically up to a certain percentage of the employee’s salary.

Let’s consider an example using the following information:

  • Employee’s Annual Salary: $100,000
  • Employee’s Annual Contribution: $4,000
  • Employer Matching Percentage: 4%

Here’s What Happens:

  1. Employee Contribution: The employee contributes $4,000 annually to their retirement account.
  2. Employer Matching Contribution: The employer matches a percentage of the employee’s contribution up to a certain limit.
    • The employer matches 4% of the employee’s annual salary in this case.
    • Employer Matching Contribution = (Employee’s Annual Salary) × (Employer Matching Percentage)
    • $100,000 × 4% = $100,000 × 0.04 = $4,000
    • Since the employer matches 4% of the employee’s annual salary, the employer’s matching contribution is $4,000.
  3. Total Contribution: The total contribution to the employee’s retirement account is the sum of the employee’s contribution and the employer’s matching contribution.
    • Total Contribution = Employee Contribution + Employer Matching Contribution = $4,000 + $4,000 = $8,000

In this example, the employee contributes $4,000 annually to their retirement account, and the employer matches this contribution with an additional $4,000, bringing the total annual contribution to $8,000.

The employer’s matching contribution effectively increases the amount of retirement savings the employee accumulates over time, providing an additional benefit as part of the employer-sponsored retirement plan.

What Can You Do?

Once you are enrolled in your company’s 401(k) plan, you can change your percentage allotment pretty frequently. Consider increasing your contribution by 10% of your salary and by 1% each year until you reach the IRS maximum contribution limit.

Are you worried that increasing your contribution will reduce your take-home pay too much? Use the IRS Take Home Pay Calculator to see how increasing your contribution will impact your take-home pay.

Additionally, if given the opportunity to speak with Plan Administrator advisors, take advantage of their time and ask your questions related to your investments so you can maximize your returns.

Don’t Have Access to a 401(k)?

If your company doesn’t offer a 401(k) or you’re self-employed, you can use another retirement savings plan.

An IRA is available to anyone earning income throughout the year. Traditional IRAs and Roth IRAs have specific requirements and contribution limits.

For business owners, your options include:

  • A SIMPLE IRA is for self-employed and small business owners. It offers higher contribution limits and mandatory contribution requirements for employers.
  • A SEP IRA is available to self-employed with or without employees. Contribution limits depend in part on annual income.
  • A solo 401(k) is for a self-employed person who can open an account themselves. Contribution limits are higher than traditional 401(k)s as contributions can be from both employee and employer.

Jason Vitug

Jason Vitug is a bestselling author, entrepreneur, and founder of phroogal.com and thesmilelifestyle.com. His purpose to help others live their best lives through experiential and purposeful living. Jason is also a certified yoga teacher and breathwork specialist and has traveled to over 40 countries.

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