What You Should Know Before Starting a 401(k)

While it may not be here yet, retirement is always on the horizon. Saving for your golden years can come in many forms but one of the most common ways is through a retirement savings account known as a 401(k). So, how do you get started? Read on to learn more and what you’ll need to know so you can make the most out of your 401(k).

If you’ve started your first job, chances are your human resources representative has handed you a stack of paperwork with hopes to get you started on saving for your retirement through a 401(k). A 401(k), named for its section in the Internal Revenue Code, is a retirement savings account offered by your employer. A 401(k) withholds your desired savings contribution from each paycheck to invest in a variety of bonds, stocks, and money market funds. With time, your money will grow, helping you live out your best life at retirement. 

Most 401(k) plans are tax deferred which means the money that is transferred into your retirement account is taken out of your earnings before you pay taxes. This reduces the amount of taxable income for the year. You won’t have to pay taxes while contributing but come time for retirement, you’ll need to pay those taxes when withdrawing. Some employers also offer ROTH 401(k)s which function just like regular 401(k)s but instead allow you to pay taxes on the contributions now instead of at retirement. This option allows you to withdraw tax-free and will save you more if you believe you’ll be in a higher tax bracket when you retire. To avoid any early withdrawal fees, you can begin to access your retirement funds six months past the age of 59. 

But one of the biggest perks of having a 401(k) comes when it’s paired with an employer match. Some employers will match up to a certain percentage of an employee's contribution which will no doubt give your savings a boost. According to Forbes, if you start savings at the age of 22 and contribute ten percent of your $40,000 a year salary to your 401(k) plan and your employer gives you a 3% match and earn a 6% average annualized rate of return, you could be looking at $1 million dollars by the time you reach the age of 65. 

While it's recommended to contribute at least 10%-15% of your income, you can always save more to meet the max contribution for the year or scale back a bit depending on your financial situation.

You’ll want to determine the kind of lifestyle you’d like to have at retirement and estimate the costs. The more luxurious the retirement, the more you’ll need to save each year. You can contribute a certain dollar amount or contribute a percentage of each paycheck.

The goal is to contribute as much as possible and at the very least, contribute to meet the match your employer provides. Not contributing to your 401(k) when it comes with a match, means you're basically leaving free money behind that could be used towards your retirement. Check out  Hughes’ retirement calculator to help you in determining how much you’ll need to fund your retirement.

Once you’re set up, you don’t necessarily want to apply the “set it and forget it” mentality. While the contribution process is usually automatic, you’ll want to check on your plan at least once or twice a year or after a major life event. These reviews will allow you to assess whether you can or should contribute more and determine if you may need to adjust where your funds are being allocated (stocks, bonds, mutual funds). Be sure to consult your financial advisor for recommendations on what works best for you.

If your employer does not offer a 401(k) there are still options to help you save for retirement. Anyone can open and contribute to a traditional IRA and just like a 401(k), an IRA also gives you tax-deferred contributions. You can also open a ROTH IRA if you’re interested in tax-free withdrawals at retirement.