How to Set Up Your First 401(k)
New college graduates have many expenses competing for their limited paychecks. Student loan bills, food, rent, and utilities can easily consume a starting salary. But 20-somethings have one very important thing going for them. Young people are in the best position of their lives to start saving for retirement. Here's how to set up your first 401(k):
Money you tuck away for retirement in your 20s has decades to compound. Make savings automatic, beginning with your first paycheck and try to ramp up your contributions whenever you get a raise. "Our goal for new employees just getting into the workforce is we want to get them to save 10 percent of their gross wages as soon as possible," says
Get a 401(k) match.
An employer match is a powerful incentive to participate in a 401(k). A company match of 50 percent of contributions up to 6 percent of pay for an employee earning
Consider a Roth 401(k).
Some companies offer a choice between traditional and Roth 401(k)'s. Traditional 401(k) deposits give you a tax break for the year you make the deposit, but income tax is due when the money is withdrawn. Roth 401(k) contributions are made with after-tax dollars and withdrawals in retirement are tax-free. The Roth option can be a good deal for young people who are currently in a low tax bracket. "People who potentially will retire in a higher tax bracket than they are in right now should use a Roth," says
Scrutinize autopilot settings.
Many large companies now automatically enroll new employees in retirement accounts unless they opt out. The most common default investment is a target-date fund. But the default investment strategy may not be right for everyone. Pay attention to how much is being deducted from your paycheck, how that money is being allocated, and what fees you are being charged. Employees must be given periodic opportunities to make changes.
Pick diversified investments.
New investors have an opportunity to buy into the stock market at low prices and benefit from rising equity values as the economy recovers. Choose a mix of stock funds, bonds, and cash that fits your personal risk tolerance. If your portfolio loses money in your 20s, you have plenty of time to recover before retirement. Pay attention to the fees and expenses associated with the investments offered by your company, which can cut into your returns dramatically over time. "If the provider offers low-cost index funds, indexes are a nice, low-cost way to build a diversified portfolio," says Berg. Also, make sure you don't overinvest in your own company by holding too much company stock. You don't want to tie too much of your retirement savings to the company. "We recommend not to have more than 5 percent invested in any one company stock," says
Balance retirement with other expenses.
It can be difficult to save for retirement when you also have student loan payments. While it's a good idea to pay off credit cards or other high interest debt as soon as possible, student loans with low fixed interest rates don't necessarily need to be prioritized above retirement savings. "If you borrow money at 3 percent and can invest it at 4 percent, then you want to do that all day long," says Kendall. "If you borrow at 3 percent and invest at 2 percent, you are eventually going to go bankrupt." Also aim to accumulate an emergency fund of at least three to six months' worth of living expenses outside of your retirement account in case you lose your job or incur an unexpected expense.
Take it with you.
When you move on from your first job, don't cash out your retirement account. 401(k) withdrawals before age 55 are hit with a 10 percent early withdrawal penalty and regular income tax on the amount withdrawn. Instead, consider leaving the cash in your old 401(k), moving the money into your new employer's 401(k), or transferring your nest egg to an IRA. All three options allow you to avoid penalties and continue tax-deferred growth. Also, some employers require workers to remain with the company for a certain number of years before the employee may keep the 401(k) match. Find out how your company's vesting schedule works and consider sticking around until you can take your employer's retirement contributions with you.
- How to Set Up Your First 401(k)
- What Your 401(k) Really Costs You
- Why Your 401(k) Still Has Not Recovered
- Don't Let Your IRA Accounts Languish
- Why Women Need Their Own Money Advice
- Health Care Reform: 10 Frequently Asked Questions
- Health Care Reform and Roth Conversions: Know the Tax Rules
- Change On the Way for Retiree Health Benefit Programs
- Two New Medigap Plans to Consider
- Modern Homesteading: How to Live Better on Less
- What Financial Reform Means For Consumers
- Five Tips to Avoid Confirmation Bias
- Start-Up Help: How to Go From Idea to Business
- Top 5 Ways to Never Waste Food Again
- Auto Financing Outlook Improves
- Mid-Year Financial Check-Up Important As Economic Woes Linger
- 10 Uncommon Sources of Income in Retirement
- These Banks Want to Help You -- Really
- How to Find Affordable Long-Term Care
- Why Some Women Skirt the Wage Gap
- What Health Care Reform Means for Medicare Drug Coverage
- Who Got Hit Worst in the Market Crash
- Sizing Up Your Retirement Nest Egg Needs
- Biggest Sources of Retirement Income
- Assembling a Sturdy Retirement Portfolio
- Withdrawing from Retirement Accounts Early without Penalty
- Social Security Inflation Adjustment Debate
- Steps to Relief From Federal Student Loans
- Funds for Recent College Grads
- Biggest Sources of Retirement Income
- Smart Moves for Tomorrow's Higher Interest Rates
- 10 Ways to Reduce Your Summer Utility Bills
- Small Changes to Get out of Debt and Save Money
- New Grads and Health-Care Reform
- Tax On Health Benefits
- Make the Most of Health Care Reform
- Don't Neglect Long-Term Care in Retirement Planning
- How the Health Care Bill Impacts Retirees
- Keeping Adult Children on Your Insurance Policy
- The Challenge of Deducting Medical Expenses
- Health Care Reform Overhaul: What Happens When
- Older Americans Comment on Health Care Reform
- Jobs With the Best Retirement Benefits
Personal Finance - How to Set Up Your First 401(k)
(c) 2010 U.S. News & World Report