How to Start a 401(k)

Whether your employer provides a 401(k) to you or not, or even if you’re self-employed, there’s no excuse not to start a 401(k) and save for your retirement. A 401(k) is one of the best ways to build wealth to live off when you decide to call it quits. Unfortunately, many Americans don’t fully take advantage of the long-term benefits saving for retirement early and often can provide. Starting a 401(k) is as easy as opening a bank account.

To start a 401(k) through your employer, you’ll need to contact your human resources department or whoever manages the company’s 401(k) plan. The 401(k)’s administrator will be able to guide you through starting a 401(k) with them. Entrepreneurs can start a solo 401(k) through any retirement brokerage or investing institution. You’ll simply need your IRS EIN to open an account and begin contributing to it.

Don’t let not knowing how to start a 401(k) prevent you from saving for retirement. It’s very easy to get started and even easier to automate your contributions going forward.

What is a 401(k)?

A 401(k) is a specific retirement account that employers provide to their employees. Using tax-deferred contributions, participants can contribute more of their paychecks towards retirement. Then, distributions during retirement are taxed at the applicable tax rate at the time.

Employers can also contribute to an employee’s 401(k). Matching contributions are a percentage of the employee’s salary that an employer will add on top of the contributions made by the employee.

There are penalties that the IRS enforces to prevent people from draining their 401(k) funds before retirement. Ineligible withdrawals made before the person is 59½ are assessed a 10% tax penalty on the amount they withdraw.

How do you start a 401(k) through an employer?

Most of the time, you’ll be asked to start a 401(k) account when you’re hired onto a company. As part of their onboarding process, they’ll forward you application forms that will include your personal information and the amount you’d like to contribute per paycheck.

However, many employers have a preliminary period you must fulfill to be eligible for their benefits package, including their 401(k) plan. For instance, if an employer requires you to be employed for 90 days before being eligible to join their 401(k) plan, you will have to wait in order to start.

If you have been with your employer for some time and have yet to start a 401(k) with them, it’s very easy to get started. You’ll need to contact your human resources department and let them know you’d like to open a 401(k) account with their plan. They will then forward you the necessary application information and will handle the administrative work for you.

You’ll then want to monitor your paychecks to make sure your elected contribution amount is correct. Additionally, you may even get information to set up online access to your 401(k) account. There you’ll be able to change your contribution percentage, check your employer’s matching contributions, and even choose different funds to invest your 401(k) into.

How to start a 401(k) when you’re self-employed.

If you’re self-employed, a solo 401(k) is what you’re looking for. A Solo 401(k) operates in much the same ways as an employer-sponsored 401(k). The difference is you act as both the employee and the employer.

This distinction allows you to have much more control over your 401(k) than you would from an employer.

You can choose to contribute pre-tax dollars into a traditional Solo 401(k) or after-tax dollars into a Roth Solo 401(k). The typical tax implications apply to either option.

Another great feature of a Solo 401(k) is you can contribute your "employee" earnings to the account but also contribute as the "employer.” You can contribute the company's pre-tax revenues—up to a certain amount—into your Solo 401(k) account. There are contribution limits, but by double-dipping your contributions, you can put away even more for your retirement.

Opening a Solo 401(k) is pretty simple. Many online brokerages provide Solo 401(k)s in their menu of account offerings. All you'll need in order to sign up are your Employer Identification Number (EIN), a plan adoption agreement, and an application. Once you're approved, you can go ahead and set up your contributions.

After your Solo 401(k) commences, you may need to file some additional paperwork. The IRS requires you to complete Form 5500-SF if your 401(k) plan exceeds $250,000 by the end of the year.

What options do you have if your employer doesn’t provide a 401(k)?

Unfortunately, not all employers offer 401(k) plans to their employees. Only about 56% of companies have some sort of 401(k). If you find yourself in this situation, you still have options to save for retirement. Although not exactly a 401(k) plan, many other retirement options operate in the same way, and others are different but still provide many benefits.

IRAs and Roth IRAs are the most common retirement account outside of a 401(k). A traditional IRA acts in much the same way as a 401(k) as you contribute pre-tax income to the account. Roth IRAs are different in that you contribute after-tax earnings.

To start an IRA, you’ll need to open an account at a brokerage or an investment institution like Fidelity or Vanguard. Opening an IRA is as easy as opening a bank account. You’ll need to provide your basic information, link a bank account in order to fund the IRA, and contribute money. However, you’ll need to contribute the funds on your own as these accounts are separate from your company and payroll.

What investments should you pick?

Once you’ve started your 401(k), you’ll need to choose what you want to invest your funds into. Most 401(k) plans default to a target-date fund. These funds contain a mixture of stocks and bonds and are reallocated yearly to match your risk tolerance as you near retirement. Using your estimated retirement date—or target date—the fund shifts more of your investments towards less-risky bond funds to limit your chance of losing money right before you retire.

However, many 401(k) plans provide many more options for their participants to invest their money. The average plan has about 19 different investment funds to choose from, ranging from mutual funds and index funds to international stock funds and bonds.

If you wish to invest your 401(k) in something other than a target fund, you’ll need to reinvest your funds yourself—either through your online 401(k) portal or your 401(k) plan’s custodian.

How much should you invest?

Retirement experts recommend contributing 10% to 20% of your income. The IRS has a contribution limit of $19,500 in 2021 and an additional catch-up contribution of $6,500 if you are 50 or older. If your employer offers a match, the total employer and employee contributions should not exceed $58,000 in 2021.

The rule of the thumb in 401(k) investing is to contribute enough to get all of the matching dollars offered by your employer. Whether your employer offers a percentage or whole dollar matching, you should not leave free money on the table. Generally, the actual amount you should put in your 401(k) may depend on the following factors:

• Your age
• How long you plan to work
• How long you will be in retirement
• The employer’s match
• Catch up contribution option for employees over 50
• Other sources of income in retirement

Leave it alone

Once you’ve started your 401(k) and have begun contributing towards it, it’s best to let your money grow undisturbed. Leaving your 401(k) alone will prevent you from incurring costly IRS penalty taxes. Additionally, taking money out of your 401(k) early will rob you of wealth-building compounding interest.

The longer your money is kept in your 401(k), the more time it has to grow.

However, the IRS requires 401(k) participants to take mandatory retirement distributions once they turn 72. Money that isn’t withdrawn will be subject to a costly 50% penalty.