How To Use Your 401(k) to Build Wealth (2024)

Whether you’ve just started a new job or you’ve been with the same company for years, it’s critical for you to understand your retirement plan benefits.

Knowing the fundamentals of your 401k savings plan will enable you to make wise choices about saving and investing for your retirement.

This is an incredibly important issue for women. Many women face a gender pay gap. Along with not investing as much, as aggressively, as early as, or for as long as men do.

Since women also carry more debt and live longer on average than men, making the most of their 401k to help close the investment gap is crucial.

There are three central questions you need to consider when setting up and maintaining your 401k savings plan, so it offers you the most benefit for your ever-changing situation.

• Related: What is a 403(b) Plan and How do You Use it?

Please note: This article assumes that you have access to an employer-sponsored 401k savings plan. If you're a freelancer or small business owner check out retirement plans for the self-employed.

Can I Afford to Participate in My 401k?

Some say, you can’t afford NOT to—but really—it’s a line item on your budget just like anything else. You need to consider your financial situation.

Do you have high-interest debt? If so, it may make sense to pay that off before participating in your employer’s 401k savings plan.

Are you living paycheck to paycheck? Are you financially strapped from taking care of your children and your parents? If so, consider these ways to free up some cash to invest in your 401k (or sock towards that high-interest debt).

If you’re just getting by, and there’s nothing left to trim from the budget, consider allocating your next raise towards starting (or re-starting) your retirement savings.

At this stage, if you've contributed to a retirement plan through a previous employer, it may make sense to consider rolling those funds into your current employer’s plan.

You’ll want to see how your money is performing in your previous employer’s 401k savings plan, first. Be sure to check on what fees that plan charges as well.

If your current employer’s plan allows for incoming rollovers. and offers better investment choices with lower fees, contact your former plan to initiate the rollover.

Note: If you decide now is not a good time for you to participate (particularly pertinent if you are a new hire), beware of automatic enrollment. Some 401k savings plans are set up to enroll new hires automatically; which results in a certain percentage of your salary being diverted into this account unless you explicitly opt-out. Please check with your HR department.

Once you determine you're ready to contribute, the next question you need to answer is:

How Much Do I Contribute to My 401k Savings Plan?

What you save into your 401k is known as your contribution. The contribution is either a percentage of your salary or a dollar amount you specify.

The funds are conveniently transferred to your 401k account via payroll deduction every payday until you reach the maximum allowable amount you can contribute for that calendar year.

The contribution limit for 2021 is $19,500. Those 50 or older can contribute an additional $6,500, known as a catch-up contribution. This is the same contribution limit from 2020.

The amount you decide to contribute should also be budget-driven. There are a couple of important considerations with this, though:

• Your contributions will (likely) be pre-tax. This means that you’re funding your 401k savings plan before the government takes its cut from your paycheck. Your taxable income lessens, and you will see a reduced amount of taxes taken from your pay. This makes contributing to your 401k less impactful to your budget than you may have previously thought. Try this payroll deduction calculator to see this in action. (Note: there can be advantages to contributing on a post-tax basis, but not all plans offer this as an option. For more about post-tax or Roth contributions check out this article.)
• Your employer probably matches your contributions (at least to a point). This means they will help fund your retirement! As an example, they may match 100% of the first 1% you contribute and 50% of the next 5% that you contribute. If you’re able, you will want to contribute enough to get your employer’s full match. In this example, you need to kick in 6% of your salary to earn the full 3.5% from your employer. If you can’t afford to contribute enough for the entire match now, make it a goal to get there over time. Never say no to free money if you can help it!

Make It Easy to Contribute

If your 401k plan offers an automatic increase feature, consider using it to increase your contributions incrementally. This feature allows you to set it so every year your contributions will increase by a given amount.

So, for example, if you have an automatic increase activated, you could have it set that every January 1st your contributions will increase by 1% up until, say, 15%. If you do NOT want this to happen, you'll need to ensure this feature is turned off.

If your plan doesn’t offer an automatic increase feature, set a reminder to review your contributions at least annually to see if you can afford to contribute more.

Now that you have an idea of how much you can afford to contribute, consider:

How Should I Invest in My 401k Savings Plan?

Putting your money in a 401k plan poses a risk. Historically, many contributors to these plans have profited from doing so. However, the funds are not FDIC insured, and you can lose money.

You need to consider how much risk you’re willing to take (known as risk tolerance) AND how close you are to retirement.

This will help determine your asset allocation (how your money distributes between investment, or asset, types).

Stocks (also known as securities) and bonds are the two most common asset types.

Stocks can fluctuate wildly in value (greater risk and higher potential reward), while bonds are more stable (lower risk and lower potential reward).

It’s generally believed you should have a mix of different asset types in your portfolio—known as diversification—to reduce your risk of loss.

It’s widely accepted that if you have a long way to go until retirement, you can withstand more risk and should, therefore, invest more heavily in stocks.

The basis of the idea is that if a market crash should occur, your portfolio would still have a lot of time to recover before the funds were needed in retirement.

Additionally, stock performance has outpaced bond performance over the last 90+ years. Favoring bonds too soon could result in a significantly smaller portfolio.

However, as retirement age gets closer, you may want to shift your investment mix to favor the less risky bond as there would be less time to recover from a down market. Despite this shift, though, you probably shouldn’t completely turn your back on stocks.

To ensure your portfolio doesn’t become eroded by inflation, some financial advisors recommend keeping some of your money in securities even during retirement. Of course, asset allocation is an entirely personal decision. If you are incredibly risk-averse, you may favor bonds from the get-go.

Conversely, if you are a risk-taker, you may hold on to a stock-heavy portfolio for longer than most investors.

There's no right or wrong answer here. You just need to weigh out the potential risks against the potential rewards and base your investment decisions on what best fits your circ*mstances.

Select Your Investments or Choose a Target Date Fund?

Once you've considered your risk tolerance and how long you have to invest before retirement, you need to decide if you're going to self-select your investments or contribute to a target-date fund.

A target-date fund might be right for you if you’d prefer your 401k savings be more set it and forget it. This fund will automatically shift the asset allocation to be more conservative as you near retirement.

Choosing your investments might be the best move if you like investing and want to be more involved. Going this route, you can customize your portfolio where a target date fund is a pre-packaged portfolio.

If you decide to self-select your investments for your 401k savings plan, you’ll need to commit to regular account surveillance and maintenance.

You’ll want to adjust your asset allocation and contributions as appropriate based on your budget, life stage, and personal circ*mstance.

Note: There is one final thing to consider when choosing where to put your money—fees and expense ratios. You will pay to invest as each fund charges administrative fees (on top of any standard 401k plan fees). Funds must disclose these charges so take note of what they will cost you before investing. Some fee structures can eat into any investment returns.

There you have it– once you’ve answered these three questions, you've essentially completed the set-up part of your 401k. Congratulations!

Some additional items and notes you'll want to pay attention to now and as time goes on:

• Find out the Matching & Vesting Schedule – Some employers offer immediate vesting while others provide a percentage for vesting over a schedule such as two or four years. This is important to know since you may not be able to take all your matching contributions in your 401k savings plan with you if you leave your employer before you're fully vested.
• Your 401k is not a Bank – Avoid taking out a loan or cashing out your 401k
• Update Your Beneficiary Info – Be sure to change your beneficiary information after any significant life event change.
• Try out Retirement Calculators – Run your numbers annually to ensure you are on track for a secure retirement.

• Stay the Course – The Market will go up and down. But it's important to stay the course and don’t make changes in a down market
• Keep Your Aim on a Secure Retirement – There may be times you want to reduce or stop contributions and use the money to pay for other things such as your child's education or a larger home. Avoid doing so. Your retirement will be here sooner than you know it and you won't be able to ‘borrow' to fund it. Keep putting away contributions for it now to avoid trouble then.
• Increase Contributions after Raises and Bonuses – Put a percentage of your increase into your 401k savings plan with every raise.
• Help Make the Plan Better – If your employers 401k plan offerings leave lots to be desired, ask them for more options; submit a request to HR for additional funds you'd like to see included.

Getting the most out of your 401k savings plan is an essential element in building your financial house for a secure life and happy retirement.

Start it early, check it regularly, and adjust it to maximize contributions, keep it diversified, and earn as much on your investments as possible.

Article written by Laura