If your employer offers a 401(k), consider yourself lucky. About half of U.S. workers don’t have access to a workplace retirement plan, and not having a plan makes it more likely that they won’t save enough for a comfortable retirement.
To get the most out of your 401(k), though, you need to understand the details of how it works. The rules and options vary by employer — some are better than others, but the overall benefits of a retirement plan are so great that you shouldn’t bypass yours even if it’s less than ideal.
Here’s what to ask before you sign up.
When can I start contributing?
The earlier, the better. An increasing number of employers automatically enroll all eligible workers in their 401(k) plan. Other companies require you to proactively sign up, and some make you wait up to a year before you’re eligible. If there’s a waiting period for your plan, consider opening an IRA or Roth IRA on your own and contributing to that in the meantime.
How much can I contribute?
Federal law dictates the maximum amount that employees can contribute in a given year, but employers may set lower limits if they want. (The federal limit is $18,500 in 2018 for people under 50 and $24,500 for those 50 and older. In 2019, the limit for people under 50 will change to $19,000.)
If your plan enrolls you automatically, you usually still have the option of contributing more than the default amount, which is typically around 3 percent. To save enough for retirement, you should be putting aside at least 10 percent of your earnings (15 to 20 percent would be even better, particularly if you start after age 35). If you can’t contribute that much, put in what you can and try to boost the amount every time you get a raise.
What’s the company match?
Most 401(k)s offer free money from the company to match at least some of your contributions. The most common match these days is dollar-for-dollar, up to 6 percent of your pay, according to Aon Hewitt. You should contribute at least enough to get all of the match.
But even if there’s no match, you should still make contributions. The money you put in will lower your tax bill and potentially can grow tax-deferred for decades. Given an 8 percent average annual return, every $100 you contribute can grow to $1,000 over 30 years and $2,000 over 40 years.
When will I be vested?
A reader once told me she hadn’t contributed to her 401(k) because she wouldn’t be vested for two years and she didn’t want to lose her money if she left during that time. Unfortunately, she’d misunderstood how vesting works.
“Vesting” means your legal right to keep money contributed by your employer. Some companies let you keep employer contributions immediately, while others require you to have been employed for a certain period before you can take the money when you leave.
The money you contribute to a 401(k), however, is always yours. Your investments may gain or lose value, but they can’t be taken away from you. Only your employer’s contribution may have “vesting” requirements, which means you have to stay employed for a specified amount of time before that match is considered yours. If your company has a five-year vesting schedule, for example, you might be able to keep 20 percent of the match after one year, 40 percent after two years, and so on until 100 percent of the match is yours after year five.
Is there a Roth 401(k) option?
The tax break you get from contributing to a 401(k) is a powerful motivator to save, but some plans offer the option of making after-tax contributions using a Roth 401(k). You don’t get the tax break up front, but the money is tax-free when you withdraw it in retirement.
Having money in both regular and Roth accounts can give you more flexibility to control your tax bill in retirement. If you’re young or expect to be in a higher tax bracket in retirement, contributing to a Roth 401(k) can make sense.
What is the cost of each investment option?
Keeping investment costs low is one key to maximizing your returns. But it’s not always easy to figure out how much your 401(k) is costing you. Regulations that were supposed to make plan costs more transparent haven’t worked as well as proponents hoped.
Still, the plan provider should give you an expense ratio for each option, which tells you how much of your return is subtracted to pay for the investment’s annual costs, like management fees. Higher costs don’t really translate into higher returns — in fact, the opposite is usually true. Your best bet often may be index funds that try to match (rather than beat) the market.
If all your options are pricey, meaning they have expense ratios of 1 percent or more, you should still invest with the plan. But ask your employer to consider switching to a less costly provider.
Where can I get objective advice?
Getting advice from someone who has no conflicts of interest isn’t easy. Generally, financial advisers aren’t required to put your interests first. They can steer you to more expensive investments that pay them a higher commission, and it’s all perfectly legal.
You might think that your 401(k) plan would be the exception, but that’s not necessarily true. Employers don’t have to provide advice when they provide a plan, or they may put you in touch with advisors who don’t have that all-important fiduciary duty to you (the one that says you come first).
So when you ask your employer if you can get advice about your plan investments, make it clear you’re looking for someone who will act as a fiduciary. If your plan doesn’t provide someone like that, you could hire a fee-only planner who will. Or you can check out a digital advice service that suggests investments for your 401(k), such as FutureAdvisor or Smart401k, or one that can manage your plan for you, like Blooom.
Liz Weston is an award-winning journalist and author of several money books, including the best-seller “Your Credit Score.”