A 401(k) is an employer-sponsored plan for retirement savings. It allows employees the benefit of having retirement savings taken out of their paychecks before taxes. The 401(k) plan is named for the 401(k) subsection of the tax code that governs how it works. If your workplace offers a 401(k), you will receive an enrollment packet that includes information about vesting, beneficiaries and investing options. It also includes information about the fees related to your 401(k), the services available to you, and how to make changes to your 401(k) investments. There are two basic types of 401(k)s—traditional and Roth. Both are employer-sponsored retirement savings plans, but they’re taxed in different ways.
A traditional 401(k) offers tax benefits on the front end. Your money goes in tax-free, but you pay taxes on the employer match (if you have one) and the withdrawals you take out in retirement. This includes all the growth on your contributions as well. A Roth 401(k) offers tax-free growth. Your contributions are taxed up front with after-tax dollars. You don’t pay taxes on your contributions or their growth when you retire, however, you will still owe taxes on employer contributions.
There are also a few other types of 401(k)s available for folks who are self-employed or own small businesses. Solo 401(k): Also known as a one-participant 401(k), which was created for business owners who work for themselves and don’t have any employees. It allows you to make contributions as both an employee and as an employer. If you’re a small business owner with no more than 100 employees, then the SIMPLE 401(k) is for you. As an employer with this plan, you must offer a matching contribution of up to 3% of each employee’s pay or put in 2% of each employee’s pay.
Both the Roth 401(k) and the traditional 401(k) have the same contribution. For 2024, you can save up to $23,000 per year (or $30,500 if you’re over 50) in your account. Since you already paid taxes on your contributions, the biggest benefit of the Roth 401(k) is that withdrawals you make in retirement are tax-free. The money you put in—and its growth!—is all yours. No taxes will be taken out when you use that money in retirement. Keep in mind that any employer match in your Roth account will still be taxable in retirement.
Another slight difference between a Roth and traditional 401(k) is your access to the money. In a traditional 401(k), you can start receiving distributions at age 59 1/2 no matter what. With a Roth 401(k), you can start withdrawing money without penalty at the same age . . . as long as you’ve had the account for at least five years.
Set up a personal IRA or Roth IRA investment account if you don’t have access to an employer-sponsored retirement savings plan. Find out what types of accounts and investments are available and pay close attention to fees. Once you set up an account, it’s time to decide how much you’ll invest in your IRA or Roth IRA. Based on your age and when you want to retire, you might want to invest in a target date fund that’s optimized for your retirement date, or a balanced fund that lets you invest in the stock market and in bonds to reduce your risk. A simple way to contribute to an investment account is to set up a monthly withdrawal from your checking or savings account.
Try setting a goal of investing 15% of every paycheck to your Roth 401(k). If you can, contribute enough in your 401(k) to get the full employer match. If you can’t save enough to get your full match today, try the 2% challenge and increase your current contribution by 2%. Then, as you receive future pay raises or bonuses, increase it by at least 2% more to maximize that match when you can. If you’re investing consistently every month—whether it’s in a Roth 401(k), a traditional 401(k), or even a Roth IRA—you’re already on the right track! The most important part of building your retirement is consistent saving every month, no matter what the market is doing.
