401k Basics Pave the Road Towards Retirement

by NerdWallet | November 21, 2013 10:31 pm

As defined benefit plans face extinction, employees are increasingly responsible for financing their own retirements. Fortunately, 401ks and other retirement vehicles give today’s employees a savings boost, through employer contributions and other incentives. And while the transition from pensions to 401(k)s has been a rough one – especially through the recession – investors are recovering.

According to data released earlier this month by Fidelity[1], the average 401k balance is up 11.1% from this time last year, to $84,300. It seems 401(k)s are here to stay, so it’s time to get informed.

How Do 401ks Work?

401k[2] plans allow you to set aside a portion of your pre-tax wages toward retirement. Your employer administers them, and in many cases, will even match a percentage your contributions. If at all possible, contribute enough to your 401k to receive the maximum employer match. It’s free money, and can make up as much as half of your retirement savings[3], especially if you’re a millennial.

Note that not all employers offer 401ks, and not every employee is eligible. If you aren’t, you can set up an Individual Retirement Account, or an IRA[4]. Even if you do have a 401), you might also want to set up an IRA simply to maximize your retirement savings because both account types limit contributions. In 2014, you’ll be able to contribute $5,500[5] to an IRA, in most cases, and $17,500[6] to a 401k.

What Are the Advantages of 401ks? 

There are a few major advantages to saving in a 401) over a traditional bank account: 

What Are the Disadvantages of 401ks? 

Unfortunately, 401(k)s have one big downside: fees[8]. You’ll probably be charged three levels of fees[9] through your 401k:

Altogether, these fees can cost over $150,000 in a lifetime for some families. Fortunately, you can minimize them. The expense ratios of available funds are usually easy to find, so compare them to ensure you’re getting the best deal. And look out for index funds. They have fewer associated fees than actively managed funds. 

What If You Leave Your Job? 

Most companies will ask that you take your 401k funds with you if you switch jobs. Rather than cashing it out, you should rollover[10] your savings into an IRA. This will probably lower your plan fees – possibly to nothing – and give you a wider range of investment options, and fortunately, it’s easy to do. If you already have an IRA, you can contribute your 401(k) balance to your existing account; otherwise, you’ll have to contact your bank or brokerage and set one up. Once you have an IRA, let your banker or broker know you’d like to execute a rollover, and they’ll handle the rest.

The Bottom Line

While 401(k)s are definitely more labor-intensive than a pension, they’re nothing you can’t handle. Once you’ve opted into your company’s plan and made some basic decisions about how to invest your money, there’s not much more to worry about. Just consider meeting with an advisor every so often – many people do this once a quarter, or once a year – to rebalance your portfolio and check on your progress. If you need to rollover your 401) into an IRA, find a broker[11] that best suits your needs and offer a wide variety of mutual funds such as Scottrade[12] or TD Ameritrade[13].

Read More From NerdWallet

73 Will Be The Retirement Norm For Millennials[14]

The Best Brokers for Options Trading Online[15]

The Best Online Brokers for Penny Stock Trading[16]

  1. Fidelity: http://www.fidelity.com/inside-fidelity/employer-services/fidelity-401k-average-balance-reaches-new-high
  2. 401k: http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/401(k)-Resource-Guide---Plan-Participants---401(k)-Plan-Overview
  3. retirement savings: http://www.nerdwallet.com/blog/investing/2013/73-retirement-norm-millennials/
  4. IRA: http://www.irs.gov/Retirement-Plans/Roth-IRAs
  5. $5,500: http://www.nerdwallet.com/blog/investing/2013/roth-ira-contribution-limits-2014/
  6. $17,500: http://www.nerdwallet.com/blog/investing/2013/401k-contribution-limits-2014/
  7. tool: http://www.nerdwallet.com/investing/best-performing-mutual-funds-401k-plan
  8. fees: https://investorplace.com/2013/05/keep-your-eye-on-the-401k-expense-line/#.Uo9h9Cf-L08
  9. fees: http://www.nerdwallet.com/blog/investing/2013/hidden-401k-fees-plan-retirement-account-study/
  10. rollover: http://www.nerdwallet.com/blog/investing/2013/401k-rollovers-roll-401k-no-fee-ira/
  11. broker: http://www.nerdwallet.com/blog/investing/best-online-brokers/stock-trading-accounts/
  12. Scottrade: http://www.nerdwallet.com/blog/investing/2013/scottrade-review/
  13. TD Ameritrade: http://www.nerdwallet.com/blog/investing/2013/td-ameritrade-review/
  14. 73 Will Be The Retirement Norm For Millennials: http://www.nerdwallet.com/blog/investing/2013/73-retirement-norm-millennials/
  15. The Best Brokers for Options Trading Online: http://www.nerdwallet.com/blog/investing/best-online-brokers/best-brokers-online-options-trading-accounts/
  16. The Best Online Brokers for Penny Stock Trading: http://www.nerdwallet.com/blog/investing/best-online-brokers/penny-stock-trading-accounts/

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