How to Set Up a 401(k): A Step-by-Step Guide

Fact checked by Suzanne KvilhaugReviewed by Katie MillerFact checked by Suzanne KvilhaugReviewed by Katie Miller

A 401(k) plan is an employer-sponsored retirement account that offers tax advantages to help employees save for retirement. Many employers contribute to their employees’ 401(k)s, which helps maximize savings. Most companies make it relatively simple to sign up, but you’ll need to do your research first.

Key Takeaways

• A 401(k) plan is a retirement savings account that employers offer.
• You must meet eligibility requirements to enroll in a 401(k) plan.
• Choosing the right contribution amount and taking advantage of employer matching is crucial for maximizing retirement savings.
• Selecting appropriate investment options based on risk tolerance and regularly monitoring the plan is essential for long-term success.

Step 1: Understand the Basics of a 401(k) Plan

All 401(k) plans work essentially the same: You contribute to your plan through payroll deductions. Some employers may use automatic deductions to facilitate more participation in 401(k) plans. This means that your employer may automatically deduct a certain amount or a percentage of your wages to put into a 401(k), unless you proactively change it or opt out. The type of 401(k) plan you have determines if your contribution is made with pre- or post-tax dollars. 

Types of 401(k) Plans 

Traditional: Contributions are made with pre-tax dollars, reducing your taxable income, and saving you money on your annual income taxes. However, these funds will be taxed when you withdraw them during retirement. In addition, to be fully vested in your employer’s contributions to the account—meaning you will own all funds and won’t have to forfeit any of your employer’s contributions if you part ways with your employer—you may have to wait a set period.  

Roth: Contributions are made with post-tax dollars, which means you will pay taxes on this income during the year it’s earned. You will not have to pay any taxes on withdrawals during retirement. (However, you may have to pay taxes on what your employer has contributed because those funds are deposited into a traditional account, not a Roth.) Roth 401(k) plans may also mandate a set timeframe to be fully vested.

Safe Harbor: This plan works like a traditional 401(k) plan, but you are fully vested for all employer contributions when they are made. That means you won’t forfeit any funds if you change your employer. 

SIMPLE: Only for employers with 100 or fewer employees who make at least $5,000 per year, the SIMPLE 401(k) works like a safe harbor 401(k) in that the employee is fully vested in all employer contributions at the time they are made.

Eligibility Requirements

Typically, all employees who are 21 or older and have worked for the company for at least one year are eligible for a 401(k) plan. However, employers can offer a 401(k) earlier than one year. 

Contribution Limits

The Internal Revenue Service sets contribution limits for all 401(k) plans each year. For 2024, that limit is $23,000 for all but SIMPLE 401(k) plans. Employees age 50 and older can contribute an additional catch-up contribution of $7,500 in 2024, for a total maximum contribution of $30,500 in all but SIMPLE 401(k) plans.

For SIMPLE 401(k) plans, the maximum contribution for 2024 is $16,000, with a maximum catch-up contribution of $3,500 for employees age 50 and older.

Step 2: Enroll in Your Employer’s 401(k) Plan

There are two ways to enroll in your employer’s 401(k) plan. The first is to enroll yourself. Your human resources manager should have the necessary paperwork for you to complete and submit to start your 401(k) plan participation. The second is your employer may automatically enroll you in the 401(k) plan by having you complete the paperwork during your onboarding process. 

Starting with 401(k) plans opened in 2025, your employer is required under the SECURE 2.0 Act to automatically enroll you in the company’s 401(k) plan unless you opt out. Employers with SIMPLE 401(k) plans, with no more than ten employees, or who have been in business less than three years are exempt from this mandate.

Step 3: Choose Your Contribution Amount

If you want to maximize your 401(k) contribution, you can determine how much of your salary is required to meet the current Internal Revenue Service (IRS) limit. For example, for 2024, you can contribute up to $23,000. If it’s not feasible to contribute the percentage of your salary to reach $23,000, choose a percentage you can afford.

If you have a choice between a traditional 401(k) and a Roth 401(k), consider the tax implications when deciding how much to contribute. Contributing to a traditional plan reduces your taxable income for the year. You won’t pay taxes on that money until you withdraw it. If you contribute to a Roth, on the other hand, you will pay taxes on that money before it’s contributed. So the key is deciding when you can afford to pay taxes: now or later, when you could be in a higher (or lower) tax bracket.  

Contribute the amount necessary to get the company to match. So, if your company matches 4% of your salary, set your contributions to 4% or higher.

Step 4: Take Advantage of Employer Matching

Employers have the option of contributing to your 401(k) plan. They may make a set contribution to every employee’s 401(k) plan, match what the employee contributes, or both. Regardless of your employer’s option, this is free money you receive in your 401(k).

Employer matches are typically between 3% and 6% of your salary. The exact amount varies from employer to employer, so find out from your human resources manager what the employer match is at your company. 

If your employer matches your 401(k) contributions, take steps to maximize these contributions by doing the following: 

• Ensure the employer match starts on time. Some employers match as soon as you become eligible for a 401(k) plan, while others require you to work for the company for a specific period before contributing. For instance, if your employer doesn’t start matching until you’ve been there for a year, ensure those employer matches start when you become eligible. 
• Stay with your employer until you are fully vested in your 401(k). Some companies set up a vesting schedule, meaning you must remain with the company for a set period to take ownership of all contributions–yours and your employer’s–in your 401(k) plan. If you leave before you are fully vested, you can only take the contributions you made to the account. 

Warning

Teresa Ghilarducci, a labor economist and professor at the New School for Social Research, has warned that the 401(k) program is insufficient for preparing for U.S. citizens’ old age and proposed a new type of national pension to replace it.

Step 5: Select Your Investment Options

With 401(k) plans, your employer usually provides a list of investment options you can choose for your plan. But it’s up to you to decide which best serves your financial goals. Typical investment options include mutual funds comprising stocks, bonds, and cash. 

A common mutual fund option is a target-date fund. These funds include a mix of investments adjusted as you approach your target retirement date. Essentially, the initial investments may be more high risk at the start of the fund, but will flip to low-risk investments as your retirement date inches closer.

Other popular choices include bond funds and index funds. Bond funds provide a share of interest, capital gains, and dividends as the bond matures. Index funds follow the trends of a specific stock market, such as the S&P 500.

Each type of investment has its own level of risks and rewards, so it’s important to review the prospectus for each to see how it performs before making a decision. 

Remember, too, that each type of investment includes management fees, so research those to determine which investment is affordable and aimed at helping you reach your financial goals.  

Step 6: Monitor and Adjust Your 401(k) Plan

Setting up and contributing to your 401(k) plan is just the start of planning for your retirement. You need to keep tabs on your 401(k) to ensure it’s working for you. Here are some tips on monitoring investment performance and making necessary changes to your 401(k) plan. 

• Keep an eye on your 401(k)’s performance. Review how your 401(k) plan is performing each year, and make any necessary adjustments to ensure you meet your financial goals.
• Adjust your 401(k) contribution each year to maximize savings. For instance, if you get a raise, take advantage of these extra earnings to increase your 401(k) contribution. This is especially important if you have yet to reach your employer’s maximum match contribution. 
• Review management fees each year. Management fees could increase when you have your 401(k), so check those at least once a year to ensure they remain affordable. If not, you may need to change how your contributions are invested. 

Is It Free to Start a 401(k)?

While your employer typically pays the plan administration costs for your 401(k), you must pay fees on your chosen investments. These vary, and are usually a fraction of a percentage or a few percents of your investment total, so reviewing all fees before moving forward is important. 

Can I Set Up a 401(k) for Myself Without an Employer?

To set up a 401(k) for yourself, you must have an employer or be self-employed. This is called a solo 401(k).

How Much Should I Start Putting in My 401(k)?

This depends on your personal financial situation, but if you can contribute enough to get your employer a match, that’s a good place to start.

What Are the Benefits of a 401(k) Compared to Other Retirement Options?

Two key benefits of a 401(k) that you don’t get with other retirement options include a higher contribution limit (i.e, $23,000 for a 401(k) versus $7,000 for an IRA) and a potential employer match. 

What Is the Average Rate of Return on a 401(k)?

The average rate of return on a 401(k) depends on the amount you contribute, the investments you choose, and the fees you pay. 

The Bottom Line

A 401(k) plan is an employer-sponsored retirement plan that provides a good way to save for retirement. Contributions can be made via payroll deduction and, depending on the type of plan, could provide tax savings. Taking advantage of an employer match for contributions could help you save even more money toward retirement. But it’s important to review and choose investments wisely to maximize your savings. And, of course, the sooner you set up your 401(k), the more time you have to build up your savings. Therefore, if you haven’t already, talk with your human resources manager to set up your 401(k) plan.  

Read the original article on Investopedia.