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How to Open a 401(k): A Simple Guide

This employer-sponsored plan is an important part of tax advantage retirement strategy.

Open a 401(k) for tax-advantaged retirement savings but you’ll have to qualify by working with a company that offers them.

Here’s everything you need to know to open a 401(k)s.

Why 401(k)s?

A 401(k) is a retirement savings plan sponsored by an employer allowing its employees to make contributions to a retirement plan. Its aim is to help you invest a percent of your paycheck. In 2020, you’re currently allowed to contribute up to $19,500 to a 401(k) or up to $26,000 if you’re 50 or older.

401(k)s have tax advantages with most offering a tax-deferred plan. So your contributions reduce your taxable income each year. 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, therefore, pay lower taxes. Some employers do offer Roth 401(k)s where your contributions are after-tax. Unlike traditional 401(k)s, Roth 401(k)s gives 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 with your company’s 401(k) Plan or you can sign up during open enrollment for existing employees.

As a new employee, you are given 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. 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.

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

Get the Most from your 401(k)

Contribute at least the amount your employer will match or else you’re throwing money away. Many employers match contributions up to a certain percentage of your salary.

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

Worried that you’ll reduce your take-home pay too much? Use Fidelity’s Take Home Pay Calculator to see how increasing your contribution will impact your takehome pay.

Additionally, if given the opportunity to speak with Plan Administrator advisors, do so to maximize your returns.

Optimize Your 401(k)

You can also use a 401(k) optimizer tool to help assess your investments. Blooom offers a free analyzer tool that can give you insights into the performance of your 401(k).

No Access to a 401(k): Your Options

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

For public school employees: A 403(b) is available only to public school employees, select ministers, and employees of tax-exempt organizations.

  • 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 for traditional 401(k)s as contributions can be from both employee and employer.
  • An IRA is available to anyone earned income throughout the year. There are traditional and Roth IRAs with specific requirements and contribution limits.

Check the financial marketplace to find online brokerages offering 401(k) alternatives.

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