Smart 401(k) Investing—Retirement Savings Overview
Before you can participate in your employer's 401(k) plan, you have to meet the plan's eligibility requirements. It's also a good idea to familiarize yourself with the contribution limits and matching benefits your employer might offer before you sign up.
With many employers, you have to sign up before you can contribute part of your earnings to your plan account. You have to choose how much to put away. And you must decide where to invest your contributions, selecting among the investment choices offered in the plan.
But a growing number of employers automatically sign up eligible employees. In that case, your employer chooses an automatic contribution rate, known as the default rate, and an automatic investment alternative, known as the default investment, for plan participants.
When you’re automatically enrolled, you have the right to change the default rate and default investment to help you meet your personal retirement goals at a level of risk you’re comfortable taking. You also can opt out of the 401(k) plan, either when you’re initially enrolled or at a later date.
Participating in a 401(k) plan gives you a head start on your long-term financial security. A 401(k) not only provides a mechanism for saving. It also allows the money in your account to compound tax-deferred. That means that the earlier you begin to participate and the more you contribute, the greater chance you’ll have of amassing a substantial retirement account.
For example, suppose you contribute $300 per month to your traditional 401(k) and earn an average annual 8 percent rate of return. If you participate for 20 years, the account could be worth $178,184. But if you had started 10 years earlier and contributed at the same rate for 30 years, your account could be worth $450,388.
Earning 8 percent with your 401(k) investments isn’t a sure thing, of course. Your account may lose value in a down market. And if the investments you choose do not provide at least the average return in a strong market, you may accumulate less than you anticipated. But if you don’t participate at all, you won’t have a retirement account to draw on after you stop working.
You must be eligible to participate before you can enroll in a 401(k) plan. But that's not a problem. Federal law requires that when an employer sponsors a plan, all employees must have an equal opportunity to save for retirement.
Your employer can impose two restrictions: that you must work for a full year—usually at least 1,000 hours over 12 months—and be at least 21 years old before you enroll. But not all employers make you wait. One of the questions you'll want to ask when you're considering a new job is when you'll be eligible to contribute to a 401(k).
Once you're eligible, though, you might not be able to enroll immediately. Plans often have specific start dates for new participants, such as once a quarter or twice a year, or during an open enrollment season. For example, if you've been on the job for a year in August, you might have to wait until October 1 or January 1. That's something else to check—though it's not the only factor you'll consider when you’re deciding between job offers.
In any year you're not eligible to contribute to your employer's plan, you may be eligible to make a tax-deductible contribution to a traditional individual retirement plan (IRA). Or, you may qualify to put retirement money into a nondeductible but tax-free Roth IRA. You probably want to check with your tax adviser to determine if you're eligible and which may be smarter for you.