When you open a 401(k) retirement savings plan, you're heaping some love on your future self. If you just got a new job, congratulations! It's a great time to sign up for a 401(k) if your new employer offers one. Even if you've been on the job for a while, you should still sign up. (No judgment; many people put off this task.) So, when you receive that inch-thick benefits packet, don’t toss aside the 401(k)-signup form and information guide like a piece of junk mail. The reason? Completing the 401(k) onboarding process and opening a retirement savings account is the first mile on the long road to a secure retirement.
Of course, these tax-advantaged accounts enable workers to have money deducted from their paychecks to invest for their golden years. It may feel challenging to lower the amount of your take-home pay now for retirement benefits later. You're only human. But a 401(k) is almost always worth it.
Why open a 401(k) plan?
“It’s certainly the first step” in building a retirement nest egg, says Kirsten Hunter Peterson, VP of workplace thought leadership at Fidelity Investments, the nation’s largest 401(k) recordkeeper by assets, according to Pensions & Investments. “The 401(k) is one of the core, critical components of your employer’s benefit package. It’s incredibly important that workers participate in their 401(k) plan and get started as early as possible because every dollar matters and every day matters when it comes to that compounding interest and what that can (add up) to in retirement.”
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Here are the five steps to starting a 401(k) account.
1. Enroll as soon as you are eligible
If you’re 21 and have been on the job for at least a year, the IRS says your company must allow you to participate in its 401(k). However, it’s likely you won’t have to wait that long. Nearly three of four (74%) companies offering 401(k) plans offer immediate eligibility for employee contributions, according to Vanguard Group. That means you can fill out the enrollment form and start socking money away for retirement when you get your first paycheck.
Increasingly, employers are doing the sign-up for you. Nearly 60% of companies with 401(k) plans now have automatic enrollment, Vanguard says. And starting Jan. 1, 2025, thanks to Secure Act 2.0, all new 401(k) plans will be required to sign new workers up at a minimum contribution rate of 3%. (You can opt-out, however.)
2. Pick an account type for your tax profile
There are two types of 401(k) plans to choose from. While both types allow your contributions and gains to grow tax-free, each has a different tax treatment.
Traditional 401(k)s, the most popular and commonly used, are funded with money from your paycheck before taxes are taken out by the IRS, which lowers your taxable income for the year. So, if you select a traditional 401(k), you’ll get your tax break upfront. You will pay taxes, however, on withdrawals in retirement.
In contrast, contributions to Roth 401(k)s are made with already taxed dollars, which means your withdrawals in retirement will be tax-free. More than eight of 10 plans (82%) now offer Roth 401(k)s, according to Vanguard.
Which type of 401k) should you pick? That decision comes down to a guesstimate on your future tax rate, says Dina Caggiula, head of participant experience at Vanguard: “Do you think your tax rate is going to be higher now or higher when you retire?” The answer, Caggiula adds, “might help you reach the optimal conclusion for what’s best for you.” If you think your tax rate will be higher when you retire (which is often the case for younger workers earning smaller salaries), then a Roth 401(k) could make more sense, as you will be able to make tax-free withdrawals and avoid the higher tax burden in retirement. In contrast, if you’re in your prime earning years and are, therefore, in a higher tax bracket than you will be in retirement, it could be a better choice to go with a pre-tax traditional 401(k) that will give you an upfront tax deduction that lowers your taxable income in your prime earning years.
3. Select investments
Picking the types of investments for your 401(k) is your choice. On average, plans offer about 18 mutual funds to choose from, according to Vanguard. These funds, which mainly invest in stocks and bonds, tend to be broadly diversified, so a single stock or sector isn’t driving your account performance. Many funds offered in 401(k) plans track a broad stock index, such as the Standard & Poor’s 500, which invests in the 500 largest U.S. companies measured by market value.
It’s vital that the investments you select have the growth characteristics that will help you reach your retirement savings goals, says Peterson. “It’s important to make sure that your money is working for you,” says Peterson. “And asset allocation (or the way your assets are divvied up) is a critical part of that. Ask yourself, ‘What’s my personal risk tolerance?’ The factors that go into that are your age, retirement time horizon, and how comfortable you are managing your own money."
Increasingly, plan participants are investing in target-date funds, which are managed by professional investors who adjust the fund’s asset mix to a more conservative posture as the saver nears retirement. A saver who plans to retire in about 30 years, for example, would select a target date fund targeting retirement in 2055. The benefit of having your money professionally managed is that “you’re not selecting the underlying investments yourself,” says Caggiula. “If you don’t have the time, the willingness, or the ability to manage the assets yourself, you can hand over the keys to someone else to manage your portfolio for you.”
Most (96%) of 401(k) plans now offer target-date funds and most plan participants (83%) invest in them. Virtually all 401(k) plans with “default” investment options use target-date funds. Like any investment, it’s prudent for the saver to compare the fees, or expense ratios, of the funds being offered. Most target date funds are now offered as collective investment trusts (CITs).
4. Contribute enough to get employee match
The amount you contribute to your 401(k) is the driving force behind the future growth of your account. Fidelity recommends that you try to save 15% of your salary, including your company’s match. But the key is to make the financial commitment to save something. “We always say a little will go a long way,” says Caggiula.
The more you contribute, the more money you will have working in financial markets over time to take advantage of compounding and grow your wealth. And if you contribute enough, you’ll also earn free money in the form of an employer-matching contribution. Financial finance pros recommend that, if possible, save a large enough percentage of your salary to get the employer match. The most common 401(k) match formula on plans at Fidelity is a dollar-for-dollar match on the first 3% and then 50 cents on the dollar on the next 2%. So, if a plan participant saves 5% or $5,000, of their $100,000 salary, their company will match $4,000.
Both types of 401(k) have the same contribution limits. In 2024, the IRS allows plan participants to contribute up to $23,000. Workers 50 or older can make a maximum contribution of $30,500. You can invest in both types of accounts to diversify your tax impact over time, but your combined contributions can’t exceed the IRS’s deferral limits.
The 2025 401(k) contribution limits for workers under 50 have increased by $500 to $23,500. The catch-up contribution limit for workers over 50 remains unchanged at $7,500. Starting in 2025, savers ages 60-63 can boost their catch-up contribution to $10,000 or 150% of the regular catch-up limit, whichever is greater. This super catch-up provision should help workers near retirement compensate for leaner years when they may not have contributed enough.
If your curious about how much others in your age cohort are saving in their 401(k)s, read The Average 401(k) Balance by Age.
5. Take advantage of automatic features
There is a push by plan providers to offer special features that help savers automate their plans and put their retirement savings on autopilot. “Employers have made if far easier than ever before for participants to enroll in a 401(k),” says Caggiula. Many plans (59%) have auto enrollment, meaning your employer signs you up for the plan, according to Vanguard, and include a default savings amount of 2% or 3%. And 69% of 401(k) plans have auto-escalation features that boost the percentage of pay savers sock away by 1% each year until a maximum deferral, such as 10% of one’s salary. “Let’s say you’re contributing 5% annually,” says Peterson. “The year after that, your contribution will automatically be moved to 6%, the year after that 7%, and 8% the year after that.”
If you are self-employed or a business owner
Don't be discouraged if you are a small business owner or are self-employed. You can still set up plans that have many of the advantages of a 401(k). We've laid it all out for you in SEP IRA vs. Solo 401(k): Which Is Better?
Bottom line
Opening a 401(k) isn’t as daunting as you might think, says Caggiula. If you’re still stressed, follow these three steps, says Caggiula. First, understand your plan and its rules. Second, start with a contribution level you can afford and feel comfortable with. And, finally, decide whether you want to select your own funds or pick a fund that is professionally managed. It’s also a smart idea to take advantage of any educational materials offered by your company or recordkeeper, such as a Vanguard or Fidelity.
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