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A 401(k) can be a great vehicle for retirement savings. So it's important to understand how to set one up and how they work. It's also important to make sure you're eligible for your workplace's 401(k) and have a Plan B if not so you are still able to save for your future.

Why 401(k) accounts?

A 401(k) is a very common type of employer-sponsored retirement plan that's available to all employees who meet certain criteria. The criteria are the employee must be 21 or older and have completed at least one year of service with the employer, usually defined as 1,000 work hours in a plan year. Some employers allow new employees to join right away, even if they haven't met these criteria yet.

In 2020, you're allowed to contribute up to $19,500 to a 401(k) or up to $26,000 if you're 50 or older. These limits are higher than what you find with IRAs, and they enable you to set aside a fairly large sum on an annual basis.

Most 401(k)s are tax-deferred, so your contributions reduce your taxable income each year. You must pay taxes on the distributions you receive in retirement, but you may be in a lower tax bracket by then, in which case you would save money. Some employers also offer Roth 401(k)s. You pay taxes on contributions to these accounts now, but distributions in retirement are tax-free.

Some employers also match a portion of their employees' 401(k) contributions. This can make saving for retirement easier since it's like your employer is giving you free money for your retirement. Each company has its own rules about matching, so consult with your HR department to learn how yours works.

How do you open a 401(k)?

Do the following to open your 401(k):

1. Figure out if you're eligible. Check with your HR department to see if you can sign up. Ask if you can sign up right away or if you must wait.
2. Find out if you have to do anything to enroll. Some employers automatically enroll eligible employees in the plan but sometimes you must initiate the process. regardless, you will need to fill out the appropriate paperwork to enroll.
3. Decide how much money you plan to contribute. This number will be based on your estimate of how much you need to save monthly to retire comfortably. You can usually choose between contributing a set dollar amount and contributing a percentage of each paycheck. Some employers require you to contribute a specific percentage to be eligible for the employer match so many use this to help judge how much to contribute.
4. Choose appropriate investment options for your contributions. Focus on finding a low-fee option, like index funds and ETFs. Make sure you keep your money diversified between stocks and bonds and among many sectors to better shield you from significant loss. Investment advice can be found through a simple Google search and standard advice will suggest riskier investments in your younger years, allowing the potential for explosive growth and if you lose money, well then at least you have time to recover. These investments should be moved into safer options as you get older so to secure the value of your savings.

 Ask HR about enrolling in your 401(k)

If you're interested in opening a 401(k), talk with your employer to learn about how your company's plan works. Some employers automatically enroll employees and withhold a default amount of their paychecks, which you can change yourself at any time. You can also opt to stop contributing to the plan if you're not interested in doing so right now. But if you're reading this, my guess is that you want to opt-in.