Investing for retirement might seem daunting. With so many retirement plan options, and even more jargon that comes with the territory, it’s no wonder some people feel anxious when figuring out how to properly invest in their 401(k). Luckily, the first step is easy—signing up for a 401(k) retirement account through your employer is often as simple as filling out a form.
As for the rest? Investing in your 401(k) doesn’t have to be complicated. From understanding your investment options and choosing your portfolio, to common mistakes to avoid, this article breaks down how and when to invest for retirement.
401(k) Easily Explained
A 401(k) is a type of tax-deferred retirement account sponsored by your employer. If you work for a non-profit, a school district, or the government instead of a company, your retirement plan might be a 403(b) or a 457(b) plan. All of these plans are employer-sponsored, meaning they pick the plan—and most of the information here applies to all three types of accounts.
You and your employer can both contribute to a 401(k). Many employers match employee contributions to some degree, and some may even contribute a portion of company profits to employees’ accounts (that’s known as a 401(k) profit-sharing plan).
Contributions are capped by the IRS : For 2022, the maximum amount an individual might contribute to a 401(k) is $20,500, with an additional $6,500 in catch-up contributions allowed for people over age 50. The total amount that might be contributed to a 401(k), including matching funds and other contributions from an employer, is $61,000 (or $67,500 for people over age 50).
5 Steps to Setting Up Your 401(k)
1. Set Up Your Contribution
Contributing is easy—just tell your payroll department how much to withhold from each paycheck. Traditional 401(k) contributions are not included in your taxable income when you put the money in; you will get taxed once you take that money out in retirement.
Some companies also offer a Roth 401(k) option, which is taxed in the opposite way—contributions are made with after-tax dollars, but plan holders don’t get taxed when they withdraw funds in retirement.
How Much Should You Contribute to Your 401(k)?
The more you save for retirement and the earlier your start saving, the better off you’ll likely be in retirement. If you’re lucky enough to have an employer that matches your contributions, at a minimum you’ll probably want to take full advantage of your employer match. (Different employers have different vesting schedules—meaning the length of time you need to work at the company in order to receive the full employer contributions. That’s information your plan administrator or HR representative should have available.)
Maximizing your 401(k) benefits you in the long run. 401(k) employer contributions vary, so it makes sense to find out how matching works at your company, and then contribute at least enough to get that “free money.”
2. Choose Roth or Traditional 401(k)
If your employer offers a Roth option (and some do not), one big question that will help you decide is: Do you want to be taxed now or taxed later?
With traditional 401(k)s, the money is taxed when you withdraw it in retirement. With a Roth, the money is taxed before you contribute it. So you’ll really want to consider whether you’ll likely be in a higher tax bracket when you retire than you are now.
If you’re early in your career trajectory with reasonable expectations that your salary will increase over time, you might want to consider a Roth, because the money will be taxed at the bracket you are now, not at the (presumably) much higher one you’ll be in when you retire.
On the other hand, if you’re in a high tax bracket now and have few deductions, but expect to have lower income in your later years, a tax-deferred contribution is one way to turn money you’d pay in taxes now into retirement savings.
3. Pick What to Invest In
A company’s plan dictates the investment choices available to employees. Most 401(k) plans offer a selection of mutual funds — but some offer only a few choices, while others may offer hundreds. Some also have the option of a stock brokerage account in which you might buy stocks, bonds, and exchange traded funds (ETFs), and there are even a few employers out there that allow you to buy company stock in your 401(k).
In considering how to invest your retirement money, it makes sense to ask yourself if you’re willing to take time to research investment options, monitor how your portfolio is performing, and make adjustments as economic and market conditions change. The answers to those questions will help you decide whether to be hands-on with your account, or to have your money managed either by a money manager or by investing in a target-date fund.
If you’re willing to do the investing homework and don’t want to just stick your retirement savings in a fund and forget about it, then self-investing may be an option. Not all 401(k) plans offer this option, but some do let you buy individual stocks rather than mutual funds.
If you’re not sure how to get started with making your investments, consider looking at a target-date fund that matches your target retirement date. Then you might use their asset allocation strategy as a jumping off point for your own investments. After that, you might make up your own mix of assets from the plan’s available choices.
A money manager will charge you something for their service, usually a percentage of the amount they are managing. They will decide the right mix of funds based on your age and risk preferences. The exact cost and methodology varies from firm to firm, but for some people it is worth the cost.
A target-date fund is a mutual fund with a passive mix of investments aimed at a “target” retirement date. The mix of assets (stocks and bonds) typically becomes more conservative as your target retirement date nears. For people who prefer a hands-off approach, these funds might be a good investment option.
Something to keep in mind is that you don’t necessarily have to pick the target date based on when you actually plan to retire. If you feel the mix of assets is too aggressive, you might choose to select an earlier retirement year to take less risk.
4. Determine Your Risk Tolerance
Every investment comes with risk. The key is assessing your comfort level with risk now, and going forward. Whether you’re picking a target date fund or making your own mix of investments, you’ll want to allocate your money based on your needs and risk tolerance.
One rule of thumb when it comes to retirement investments is that the younger you are, the more risk you might be able to handle. The thinking goes that you will have more time to recover from market drops to allow riskier investments to pay off.
On the other hand, people closer to retirement may choose to adjust their investments. There, the goal would be to minimize risk, so that the savings they will soon need would not be overly impacted by a market downturn.
5. Integrate Retirement Savings into Your Overall Investment Portfolio
Once you’re an experienced saver and have been investing for a while, it might be helpful to look across all your investment accounts, rather than thinking of your 401(k) in isolation. When you look at the full picture, you might balance your asset allocation across your whole portfolio and consider both the tax shelter a 401(k) provides and the investment choices available to you.
You may also choose to utilize the best fund choices in the plan that fit your asset allocation, and then flesh out the rest of your portfolio in non-401(k) accounts where you have more flexibility.
For example, even if an employer provides very limited choices, a typical 401(k) plan probably has an S&P 500 index fund. It’s also likely that your overall asset allocation calls for some portion in US Stocks. If that’s the best fund available, you might decide to use it as part of your US Stocks allocation.
To see if you are on track for retirement, use our retirement calculator.
3 Common 401(k) Investing Mistakes to Avoid
People tend to make two common mistakes with their 401(k)—and both have to do with diversification.
Investing Exclusively in Company Stock
Putting all your money in company stock, while also working at the company, is a potentially risky move. Worst case scenario, the company could go out of business—putting you out of a job and decimating your retirement savings. It’s widely considered to be too many eggs in one basket.
Even if you love your company and really believe in it, a safer idea may be to consider putting no more than five or 10% of your total assets in any company’s stock.
Putting Everything into a Money Market Fund
A money market fund is a mutual fund made up of relatively low-risk, short-term securities. It’s a tempting move, because it feels like you don’t risk losing money.
But inflation in the US is currently about 1.4% , and according to Business Insider , the national average yield for money market funds is about 0.07%. This means that any money invested in a money market fund is likely losing value after inflation. Your retirement savings need to grow, while there are no guarantees in stock or bond funds, with these return rates, money funds are likely not the answer.
Leaving Old 401(k)s Open
When you leave your current employer, it’s often a good idea to roll over your 401(k) into a traditional or Roth IRA. Most 401(k) accounts have fees associated with them. While typically an employer will pay those fees while you work for them, once you’re no longer with the company, many will stop paying them for you.
By moving your money into an account of your choosing, you have more control over the fees you pay. You’ll also generally have a broader range of investment choices.
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Investing in a 401(k) retirement savings account is fairly simple, especially since you can set it up through your employer. Whether you are typically a hands-on investor or prefer a hands-off approach, you can get your 401(k) contributions up and running—and start saving money for your future.
If you have an old 401(k), as noted above, you might want to consider doing a rollover to an IRA account so you can better manage your savings in one place.
SoFi makes the rollover process seamless — and you don’t have to watch the mail for your rollover check. There are no rollover fees, and you can complete a 401(k) rollover without a lot of hassle.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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