As a source of retirement income, the 401(k) is second in popularity only to Social Security, and it has the potential to generate strong returns. In fact, nearly 10% of American adults qualify as millionaires largely due to their retirement savings.[1] But here’s the catch: With rising costs and longer life expectancies, $1 million may not stretch as far as it once did, especially if you retire in your 60s. So how can you help your 401(k) work harder?
It starts with a smart strategy. Optimizing your 401(k) requires a mix of saving, investing, and tax planning. Whether you already have an account or need to know how to set up a personal 401(k), we’ve got some 401(k) tips to help you make your money grow.
What Is a 401(k) and Why Should You Open One?
A 401(k) is a retirement savings plan sponsored by an employer that allows you to automatically save and invest a portion of your paycheck pre-tax. The plans can provide a powerful and tax-advantaged way to build potential wealth for the long term. Your contributions to a 401(k) can help lower your taxable income now, and investments grow tax-deferred. Plus, many employers offer free matching funds, providing an instant return on your own investment.
Let’s also not forget the power of compound interest, which Albert Einstein called the 8th wonder of the world, noting, “He who understands it, earns it; he who doesn’t, pays it.” Here’s a hypothetical example to help explain how compound interest can work in a 401(k):
If you have $100,000 in your 401(k) earning a 5% return each year, your balance grows not just on your original investment but on the interest it earns. After the first year, your account would be worth $105,000. In year two, that full amount earns 5%, giving you $5,250 in growth—and the compounding continues. After 30 years, that initial $100,000 alone could potentially grow to more than $400,000.
Who Can Open a 401(k)?
If you’re wondering how to set up a 401(k), it’s important to know that unless you’re a business owner or self-employed you cannot open a 401(k) on your own. A 401(k) is an employer-sponsored retirement plan. Not all employers offer them, however, and those that do will generally have eligibility requirements, like needing status as a full-time employee.
How to Set Up a 401(k)
Setting up a 401(k) plan is a straightforward process handled through your employer’s benefits system. To get started, follow these steps:
- Confirm your eligibility: Check to see if you meet your employer’s requirements, such as length of employment.
- Access your plan portal: Log in to your benefits or portal provided by your employer.
- Choose your contribution amount: Decide what percentage or fixed amount of your pre-tax paycheck you want to contribute.
- Select your investments: Allocate your contributions among the investment options offered, such as target-date funds or index funds.
- Review and submit: Finalize your selections and enroll. Your employer will automatically deduct contributions from your paycheck, and many employers also provide a matching contribution.
How to Set Up a Solo 401(k) if You’re Self-Employed
If you’re self-employed, you may be wondering if you can set up a Solo 401(k). You absolutely can if you have no employees other than your spouse. To set up a Solo 401(k), follow these steps:
- Choose a provider that offers Solo 401(k) plans.
- Complete the provider’s application to formally establish the plan, including naming yourself as the plan’s trustee.
- Start making contributions. As a self-employed individual, you can contribute as both the “employee” (making elective deferrals up to the annual limit) and the “employer” (adding profit-sharing contributions up to a percentage of your net earnings).
401(k) Tips for Setup
What kind of 401(k) should you set up? Two of the most popular options are Traditional and Roth 401(k)s, which differ in tax treatment. With a Traditional 401(k), you pay taxes when you withdraw money from your retirement plan. With a Roth, you pay taxes before you contribute to the plan.
How do you decide which option is best? The big question is, will you be in a higher tax bracket now or in retirement? If your tax bracket is likely higher now, elect to participate in a Roth. If you think you’ll have more income in retirement, then choose a Traditional 401(k).
You may be able to participate in both, so ask your employer’s benefits department or wealth advisor for guidance.
401(k) Tips to Maximize Your Retirement Savings
After you set up a 401(k) plan, the next step is choosing your investments. How do you decide where to put your money (and hopefully matching funds supplied by your employer)? Here are some 401(k) investing tips:
- Consider target-date funds for simplicity: A target-date fund is a single, diversified option that automatically adjusts its asset mix (stocks vs. bonds) to become more conservative as you approach your target retirement year. This is a “set-it-and-forget-it” option for those who are seeking simplicity.
- Diversify with core asset classes: If you’re building your own personal 401(k) portfolio, invest across major asset classes. This usually means selecting a mix of U.S. stock funds, international stock funds, and bond funds to spread risk and capture growth in different market sectors.
- Invest for the long-term and then stay calm: Remember the old maxim: “Time in the market is more important than timing the market.” Wherever you choose to invest, be careful of reacting to every shift in the market, take the advice of a professional advisor, and stick to your plan. If you change your 401(k) investments every time there’s market volatility, you could lose big in the end.
- Invest with your own personal journey in mind: There is no such thing as a one-size-fits-all investment strategy. For example, if you’re 27, you may want to invest your 401(k) in more aggressive funds because you have more time to recover in the event of market drops. If you’re 60 and nearing retirement, your risk profile should be different because you will need that money to live on soon, and you don’t have as much time to recover from major market losses.
- Engage with an advisor who offers tailored advice: Your plan should ideally be responsive to your goals, your values, and your life journey.
Take the Guesswork Out of 401(k) Planning
Take the guesswork out of 401(k) investing by leveraging the experience of a trusted wealth advisor who can provide personalized guidance tailored to your unique financial picture, risk tolerance, and retirement goals. Partnering with a professional can help you organize your portfolio to stay aligned with your long-term objectives. An advisor can also help you navigate market fluctuations and avoid emotionally driven investment decisions, ultimately providing confidence and clarity on your path to retirement, replacing guesswork with strategy.
How to Set Up a 401(k) FAQs
How much does it cost to set up a 401(k)?
For employees, there is typically no direct cost to set up a 401(k), as the employer bears the administrative expenses. Most brokerage firms do not charge a fee for setting up a Solo 401(k) either.
How much should I contribute to my 401(k)?
If your employer provides a matching investment, contribute at least enough to your 401(k) to get your employer’s full match. Then aim to increase your contributions toward the annual maximum as your budget allows.
What steps do I need to take to set up a 401(k)?
Contact your company’s human resources department or benefits administrator to enroll and then choose your contribution amount and select your investments from the options provided in the plan. If you are self-employed, reach out to a financial advisor for support in setting up a Solo 401(k).
What are the best funds to start with in a 401(k)?
Talk to your financial advisor for professional advice on which option could work best for your current and future needs.
Can I change my investment options later?
Yes, you can typically change your 401(k) investments at any time through your plan’s online portal.
Ready for guidance on setting up a 401(k) or other retirement plan?
Find a Carson Wealth advisor near you.
[1] APNews.com, “Millionaires multiply across the US, but most find it’s not all mansions and champagne, https://apnews.com/article/wealth-retirement-millionaire-stocks-homes-inflation-8bc8bf04552feac2625afd6752faa29e
Distributions from employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty.
The examples in article are hypothetical only, and do not represent the actual performance of any particular investment. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
A diversified portfolio does not ensure a profit or protect against loss in a declining market.
The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value.
Investors cannot invest directly in indices. The performance of any index is not indicative of the performance of any investment and does not consider the effects of inflation and the fees and expenses associated with investing.
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