How to Set Up a 401(k) and Start Investing for Retirement [2024]

One of the most important things you can do for your future is to save for retirement. When you invest in a retirement savings account, especially using a tax-advantaged plan, you might be more likely to live in relative comfort after you finish working. Though it’s important to remember all investments come with risk.

There are several different choices when it comes to investing for retirement. One of those options is a 401(k) account. Here’s what you need to know about how to set up a 401(k) so you can potentially grow your wealth over time.

Why open a 401(k)?

A 401(k) is a retirement account offered by employers that comes with certain tax advantages. As you try to grow your wealth for the future, a 401(k) can be helpful because it allows you to set aside money from each paycheck. With certain types of 401(k) accounts, employers may also offer to match employee contributions up to a certain percentage each year. Employer matching contributions are essentially free money, so this can be a valuable perk. Over time, as you invest your contributions, you can potentially build a nest egg designed to set you up for a comfortable retirement.

Many workers, especially those who plan to retire after age 59 1/2, might benefit from having a regular, automatic way of saving for retirement. Though as noted above, all investments come with risk, so it’s important to weigh the potential benefits against the risks as you consider your options.

Types of 401(k)s

There are a few different types of 401(k) accounts — including those available to the self-employed. Understanding how each account works can help you learn more about how to invest money for the future.

Traditional 401(k)

A traditional 401(k) is a common type of plan that allows you to set aside money today, with pre-tax dollars. This effectively reduces your tax liability right now and your investments are tax-deferred. You do have to pay taxes when you withdraw money from the 401(k) during retirement, but you might be in a lower tax bracket by then, depending on your situation. It’s also important to note that a traditional 401(k) comes with required minimum distributions (RMDs), which means that you’re required to take a set amount of money from your account once you reach age 72.

For 2024, 401(k) contribution limits are $23,000 with the option to make an additional catch-up contribution of $7,500 if you’re at least 50 years old.

Roth 401(k)

A Roth 401(k) is similar to a traditional 401(k), except that instead of using pre-tax dollars to fund your account, you make your contributions with post-tax dollars. As a result, you pay taxes on the money today, but your investments could potentially grow tax-free over time. When you withdraw money from your account, you won’t need to pay taxes on that money. The Roth 401(k) is also subject to RMDs.

Contribution limits for a Roth 401(k) are the same as for a traditional 401(k). Note, however, that your contribution limit is combined between accounts, so your total contributions to a Roth and a traditional 401(k) can’t exceed the annual limits set by the IRS.

SIMPLE 401(k)

If you’re a small business owner or self-employed, you might choose to establish a SIMPLE 401(k) if your company has less than 100 employees. With a SIMPLE 401(k), you typically have fewer administrative requirements than what you might see with a traditional or Roth 401(k).

However, it’s important to note that employers are required to contribute money to their employees’ SIMPLE 401(k) plans. As a business owner, if you decide to set up a SIMPLE 401(k), you need to be aware of this requirement. Of course, as an employee of the business, you can also choose to contribute to a SIMPLE 401(k).

Contributions limits for a SIMPLE 401(k) are lower than what you’d see with some other 401(k) accounts. For 2024, the contribution limit is $16,000, and an additional $3,500 for those 50 and over. That's up from $15,500 (or an additional $3,500 for over 50) in 2023.

Safe harbor 401(k)

A safe harbor 401(k) is another type of retirement plan designed to allow business owners the ability to have a little more flexibility in the way they manage the plan. Like the SIMPLE 401(k), certain administrative requirements for managing a traditional 401(k) are waived with a safe harbor plan.

As with the SIMPLE 401(k), employers are required to make contributions to their employees’ plans, and those contributions are immediately and fully vested.

In 2024, the contribution limit for safe harbor plans is $23,000, the same as the traditional 401(k), with a $7,500 catch-up contribution for those 50 and older.

Solo 401(k)

For those who are self-employed but don’t have any employees, a solo 401(k) might make sense. It’s possible to cover a spouse with a solo 401(k), but other than that, you must not have employees if you plan to set up a solo 401(k).

In addition to making traditional solo 401(k) contributions with pre-tax dollars, it’s also possible to set up a Roth solo 401(k). You can decide which is likely to work best for you based on your unique situation.

The contribution limit for a solo 401(k) is the same as for a traditional 401(k). However, there is a bit of a twist. Because you’re both the employee and the employer, you can also make additional contributions as an employer. So, you could make your $23,000 in contributions (for 2024) as an employee and then make an employer contribution of up to 25% of your compensation. Total contributions for 2024 can’t exceed $69,000 (or $76,500 for over 50).

How to set up a 401(k)

Because traditional, Roth, safe harbor, and SIMPLE accounts are employer-sponsored, it’s a good idea to talk to your human resources department about how to set up a 401(k). You’re also likely to get information about the enrollment process as a new employee. For the most part, all that’s needed to start your account is for you to decide how much of your paycheck you want to have withheld as contributions to the plan.

In general, your 401(k) plan will typically be managed by an outside brokerage. Your employer is the plan administrator and has a fiduciary responsibility to make sure that the employees have access to the best plan options for them.

When you get started with a new 401(k) plan, you’ll likely receive an account login from the financial firm managing the investments. There’s also a good chance you will need to make a fund selection from available investment options to make sure your money is actually being invested, rather than just sitting in the account, earning only a nominal amount of interest.

Some employers also offer the chance to make Roth contributions. Realize, though, that if your employer matches your contributions, their portion will actually be held in a pre-tax account like a traditional 401(k), while your contributions are held in the Roth.

How to set up less-common 401(k) plans

As a business owner, you might decide to set up your own plan. You’ll need to find a financial institution or broker that allows you to set up plans for your workers or a solo 401(k) for yourself. Fidelity, Betterment, and TD Ameritrade are just some examples of brokers that can help you set up plans for employees and yourself.

If you have employees, a SIMPLE 401(k) might help you provide a benefit for your workers without meeting some of the requirements expected of a traditional plan. This can simplify your paperwork and make the plan easier to administer.

On the other hand, if you don’t have employees, it’s fairly straightforward to open a solo 401(k) with a broker that offers that choice. You might even choose to open a Roth solo 401(k) and make after-tax contributions that you can withdraw tax-free later.

Finally, if you decide you want to add a safe harbor provision to your 401(k) plan, you need to go through a notification process to let employees know about any changes. You could set up a safe harbor 401(k) from the beginning, but it’s important to look for a plan provider that specializes in custom retirement plans and is willing to help with the process.

What to consider when opening a 401(k)

As you consider whether to participate in your employer’s 401(k) — or to open a solo 401(k) — it’s important to think about whether it’s the right choice for you. When making your decision, consider the following:

• Risk tolerance: Think about how much risk you can handle financially as well as emotionally. Plan for money you set aside in a 401(k) to be locked up until you reach age 59 1/2. While there are ways to access the money penalty-free before then, it’s a good rule of thumb to only put in money you know you probably won’t need in the immediate future.
• Investment choices: Look at the investment choices available in your company’s 401(k) plan. In general, you’re likely to find target-date mutual funds, index funds, and other types of mutual funds. Other common investment options include company stock and variable annuities. While some retirement plans might offer Exchange Traded Funds (ETFs), you’re more likely to find those choices when you open a solo 401(k).
• How much you plan to invest: Decide how much you want to invest and whether you can increase your contributions each year. One of the best ways to ensure that you reach your retirement goals is to arrange for automatic increases in your contributions each year. However, it’s important to remember that all types of investing come with the risk of loss.
• Vesting schedule: When you have an employer match, that money isn’t always immediately considered yours. In some cases, you might have to wait two to five years (or longer) before the employer match is truly yours. If you leave the company before the vesting period is over, you might not be able to roll some or all of the funds resulting from your employer’s contributions. Pay attention to the vesting schedule before moving forward.
• Fees: Don’t forget to pay attention to fees. Even though fees have been coming down in recent years, retirement plan fees can potentially eat into your real returns.

Alternatives to a 401(k)

If you’re not sure about using your employer’s 401(k), there are some other ways to invest for retirement, including different IRA types. Some of the alternative retirement savings vehicles that may be available to you include:

• Individual Retirement Account (IRA): Anyone with earned income can open an IRA. A traditional IRA allows you to claim an income tax deduction for your contributions, lowering your current tax liability. However, you do pay taxes later, when you withdraw your funds in retirement. Also, note that the contribution limit is much lower for IRAs — $7,000 for 2024 (with a $1,000 catch-up contribution).
• Roth IRA: If you meet the income requirements for this account and have earned income, you can make after-tax contributions to a Roth account and your money could potentially grow tax-free. On top of that, unlike the traditional IRA and the 401(k), a Roth IRA doesn’t come with RMDs.
• SEP IRA: For those that are self-employed, a SEP IRA offers the simplicity of an IRA, but with higher contribution limits. You can contribute up to $69,000 or 25% of compensation, whichever is less. However, there is no Roth option with a SEP IRA.
• Health Savings Account (HSA): If you meet the requirements for a health savings account, you can set aside money for future costs. Contributions to an HSA are tax-deductible, and the money can be withdrawn tax-free as long as it’s used for qualified medical expenses. It’s also possible to invest a portion of your HSA, allowing you to use it for later healthcare costs, or even as a back-up IRA when you reach age 65 (although you’ll have to pay taxes on the non-qualified withdrawals).
• Taxable investment account: Finally, you can use a taxable account to invest your money. In many cases, you can find low-cost funds and save on fees. However, it’s important to note that you won’t receive special tax treatment, beyond a break in capital gains taxes if you hold your assets for more than one year. On the other hand, there aren’t penalties when you withdraw your money or for how you use it.

You can also use a 401(k) in conjunction with these other accounts. If you plan to retire early, it could make sense to incorporate a taxable account and an HSA in your planning so you can access some of the money for different purposes without worrying about penalties.

Think about your long-term goals and financial situation, and consider consulting with a financial advisor to help you figure out how to create a retirement plan that uses different accounts for different needs. No matter what, though, make a plan to get started. A common retirement mistake is waiting too long to save.

FAQs about 401(k) accounts

The bottom line

A 401(k) could potentially provide you with a way to build a nest egg for retirement by simply using contributions from your paycheck. With a 401(k), you set aside money on a regular basis, and you receive tax benefits designed to encourage you to keep your money in the account until you reach retirement age.

Your 401(k) could be an important part of your retirement planning and, used in conjunction with other investment accounts, offers the potential to help you reach your financial goals.