Most of us aren't putting away enough money to live comfortably in our golden years. In fact, the stats are pretty staggering: According to an analysis by the Government Accountability Office [PDF], about half of households age 55 and older have zero retirement savings.
You might have Social Security or a pension to fall back on, but for a lot of us, that’s just not enough. The sooner you start saving, the better. And if your employer offers a 401(k) plan, chances are they also offer some kind of matching benefit. Meaning, if you save a certain amount, they’ll match your savings, dollar for dollar. (It’s a pretty sweet deal.)
Once you decide to invest in a 401(k), however, your decision-making—and paperwork-navigating and fine-print-reading—has only just begun. Here’s how to get started
1. DECIDE HOW MUCH TO SAVE.
First things first: You’ll have to decide how much you want to deduct from your paycheck. As a general rule of thumb, most experts suggest saving at least 10 to 15 percent of your salary for retirement.
“We recommend saving a total of 15 percent, including any contribution your employer makes, throughout your career, but realize not everyone can start there,” says Meghan Murphy of Fidelity Investments. “Save at least enough to take full advantage of any employer match.”
Murphy suggests increasing your contributions by 1 percent each year until you hit 15 percent. (If that seems daunting, you can set up automatic increases so that "paying yourself first" becomes non-negotiable.) If you want a more detailed idea of what you should save for retirement, this calculator will help you figure it out.
2. ALWAYS TAKE THE FULL MATCH.
Your employer 401(k) match is almost like free money; they’re essentially giving you money to save. For example, it’s common for employers to match 50 percent of your contribution for up to six percent of your income. If you earn $40,000 a year, that means you can get up to $1200 per year from your employer. (If you want to crunch your own numbers, this handy calculator can help.)
Because it's such a great deal, you want to take full advantage of the opportunity and save as much as you can to get the full match—so, in the above scenario, you'd want to make sure you set aside that full six percent, or $2400 a year, for your retirement. With 26 pay periods a year, that equates to contributing $93 of every paycheck.
Obviously, not everyone is in a position to swing this financially, but you'll want to try so that you don't leave money on the table. Make your contribution automatic, and you’ll probably never miss the money anyway. If you can afford to save more, even better.
3. CONSIDER YOUR TAX SAVINGS.
Another reason the 401(k) is awesome? The money you save is “pretax,” which means the contribution is taken out of your paycheck before your taxes are. So, when it comes time to do your taxes in April, your taxable income will be lower than if you had not saved for retirement (and therefore, your taxes will be lower as well).
Of course, you’ll have to pay taxes on this at some point, but not until you withdraw the money at retirement. In the meantime, saving in your 401(k) will help reduce your tax bill.
Because of this tax advantage, the IRS sets 401(k) contribution limits. In 2016, you can contribute no more than $18,000 out of pocket for the year (for employees age 49 and below). If you're 50 or over, you can save an additional $6,000 in catch-up contributions. But that’s just your individual limit. With an employer match, you can save even more (up to $53,000 for 2016)—but your out of pocket is still capped at $18,000. Those numbers are probably crazy high for most of us, but the point is, there’s a limit to how much you can save.
4. PICK YOUR INVESTMENTS.
When you save money in your 401(k), the plan provider invests that money for you. That means they need to know how exactly you want to invest your cash.
Most 401(k) plans simplify this entire process by offering target date funds. With these, you simply choose a fund based on your age. If you’re new to investing and have no idea where to start, target date funds are an incredibly easy way to jump in.
Not all plans offer easy target date funds, though. Some funds are organized by stocks and bonds. For these, you’ll have to figure out your asset allocation. Your assets are your investments (like stocks and bonds), and your allocation is how much you’re invested in each asset. You can use a calculator like this one to figure out your asset allocation in detail, but here’s the ballpark rule of thumb:
110 - your age = the percentage of your portfolio that should be stocks
If you’re 30, that means you want 80 percent of your investments in stocks and 20 percent in bonds. Some would argue this is a conservative estimate, but it at least gives you a starting point. Once you figure that out, it’s time to pick your investment options. Depending on what your 401(k) plan offers, pick the funds that best match your target asset allocation.
And if this is all still confusing, phone an expert.
“Don’t be afraid to ask questions,” says Murphy. “There are lots of ways to get help with your saving and investing questions; take advantage of the help offered to you through your employer to set goals, both for retirement and other financial needs.”
5. KNOW YOUR FEES.
One big drawback of a 401(k) is the fees: They’re notorious for charging high management fees (or expense ratios), and these add up over time. Plus, they offset some of the return you earn from investing in the first place. Here’s how the Motley Fool suggests figuring out your fees:
It's up to you to figure out your 401(k) plan's expense ratio. You can do this by adding up all of the fees assessed against your account in any given year and then dividing them by the value of the account's holdings. According to the '401k Averages Book,' this ratio should fall between 0.31% on the low end and 1.88% on the high end.
You can also use a tool like FeeX to find those fees for you and tell you how much you’re paying. If your fees are on the high end, you might consider saving only enough in your 401(k) to get the employer match. Beyond that, you’ll get more bang for your buck saving on your own, in an Individual Retirement Account (IRA).
Overall, though, the 401(k) is a great tool for investing. And that employer match is an even bigger motivator to save.