Savings plan for retirement – 401(k)

“And in the end, it's not the years in your life that count. It's the life in your years." Abraham Lincoln

Savings plan for retirement – 401(k)

A 401(k) is a type of savings plan for retirement offered by employers that helps you save money for the future. It works by taking a portion of your paycheck before taxes are taken out, this is called making "pre-tax contributions." That money goes into an investment account where it can grow over time, usually through options like mutual funds or stocks. Because you’re not taxed on that income right away, it can lower your current taxable income. Many employers also offer to match part of what you contribute, which is like getting free money. You’ll pay taxes later when you withdraw the money in retirement.

How to get started with 401(k) savings plan for retirement:

1. Check if your employer offers a 401(k)

Start by asking your HR department or checking your employee benefits package. If a 401(k) is offered, they’ll provide enrollment instructions.

2. Enroll in the plan

Follow your employer's enrollment process. You'll need to provide some basic information and choose how much of your paycheck to contribute (a % of your salary) into your savings plan for retirement.

3. Decide on your contribution amount

Pick a percentage of your pay to contribute. A common starting point is 5%–10%, especially if your employee offers a match. Try to at least contribute enough to get the full match, it’s free money.

4. Choose your investments

You’ll select where your money goes (e.g., mutual funds, target-date funds, etc.). If you’re not sure, a target-date fund based on your expected retirement year is a simple option.

5. Review and adjust over time

Once it’s set up, check in on your account once or twice a year. You can adjust contributions or investments as your situation or goals change.

Things to watch out for:

Risk tolerance is how comfortable you are with the ups and downs of investing, especially the chance of losing money in the short term. Some people are okay with taking big risks if it means possibly getting bigger returns. Others prefer to play it safe, even if that means slower growth.

It's important because it helps you choose the right investments for your 401(k) or other savings plan for retirement accounts. If you take too much risk, you might panic and sell when the market drops. If you’re too cautious, your money might not grow enough for retirement. Knowing your risk tolerance helps you invest in a way that fits your comfort level and long-term goals.

A vesting schedule is a timeline that shows when the money your employer adds to your 401(k) (like matching contributions) officially becomes yours to keep, even if you leave the company.

You always own the money you put in, but the employer’s part might take time to fully "vest."

For example:

• If your company has a 3-year vesting schedule, you’ll need to stay for 3 years to keep 100% of the money they added.

• If you leave earlier, you might only keep part of it, or none.

It’s important because it affects how much of your savings plan for retirement you take with you if you change jobs.

Example: Graded Vesting (3-Year, Annual Increase)

• You become partially vested each year, increasing gradually.

Example Timeline:

• Year 1: 33% vested

• Year 2: 66% vested

• Year 3: 100% vested

If your employer contributed $3,000 over 3 years:

• After 1 year: You keep $1,000

• After 2 years: You keep $2,000

• After 3 years: You keep all $3,000

...and remember

A 401(k) typically isn’t something you just set and forget forever. It’s a good idea to review your investments at least once a year to make sure your savings plan for retirement still aligns with your goals and risk tolerance, especially if your life situation or retirement timeline changes. However, checking your account too often can backfire. Investments naturally go up and down and watching those short-term swings too closely might lead to emotional decisions, like pulling out of the market at the wrong time. Staying focused on the long term is usually the best strategy.

What is an employer match?

An employer match is when your company contributes money to your 401(k) based on how much you contribute. Your employer decides how your 401(k)-match works, but it usually follows a simple formula. For every dollar you put in, they’ll add either the same amount (full match) or part of it, like 50 cents for every dollar (partial match). Sometimes they use a mix of both. They also set a limit, usually based on a percentage of your salary, on how much they’ll match. It’s a way for employers to help you save for retirement, and it’s essentially free money added to your account.

Example:

401(k) savings plan for retirement might use the following setup: Your employer matches dollar-for-dollar until you've contributed 3% of your salary. Then they match 50 cents of every dollar up to another 2% of your salary. Any contributions you make above 5% of your salary will not be matched. If you contribute less than 3%, you get less of the match.

So, if you earn $50,000 and contribute 3% ($1,500), your employer also puts in $1,500, doubling your savings that year.

Why it matters:

Not taking full advantage of your employer’s match is like leaving money on the table and walking away. Contributing at least enough to get the full match is one of the smartest financial moves you can make early on.

Savings plan for retirement such as 401(k), is a great way to save for retirement by putting aside money from your paycheck before taxes and often getting extra contributions from your employer. To start learning more about investing, The Little Book of Common-Sense Investing by John C. Bogle is an excellent resource for building a solid foundation.

Next, check whether your employer offers a retirement savings plan. If so, decide how much you want to contribute, select investments that align with your risk tolerance, and make sure you understand key details, such as your vesting schedule.

Remember to review your account at least once a year to make sure it still fits your goals but try not to react to every market change emotionally. Staying patient and focused on the long term will help your savings grow and set you up for a more secure future.

Disclaimer:

The Frugal Edit is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a website to earn advertising revenues by advertising and linking to Amazon.com. This is at no additional cost to you, if you choose to make a purchase, we may earn a small commission to help support our work. Please note that we do not receive any free products to promote.

Disclosure:

Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. Always consider your financial situation, goals, and risk tolerance before making investment decisions.