Not everyone has access to a 401(k), but if your employer offers one, you have a great opportunity to build a substantial nest egg for the future. That's because 401(k)s offer much higher annual contribution limits than IRAs. Currently, you can sock away up to $19,500 annually if you're under the age of 50, and if you're 50 or older, that limit increases to $26,000. With that in mind, here are a few things you can do to get the most out of your 401(k).
1. Contribute enough to snag your full employer match
A large number of employers that offer 401(k)s also match employee contributions to some degree, and that's effectively free money going into your account. Be sure to find out what your company's match looks like so you contribute enough to take advantage of it. Keep in mind that matches are often dished out as a percentage of salary, so your employer might, for example, match up to 3% of yours. If you earn $50,000 a year, it means you'll need to contribute $1,500 from your own earnings to get $1,500 from your employer.
Now, imagine you get an extra $1,500 from your employer every year in your 401(k) over a 20-year period. If you invest that money at an average annual 7% return, which is likely if you load up on stock investments, you'll wind up with an extra $61,500 in savings just from the money your employer put in.
2. Choose the right investments
Your goal in setting up your 401(k) investments should be to maximize your gains while minimizing your fees, and stock-based index funds are a good way to do both. With a 401(k), you get to choose between actively managed mutual funds and index funds, which aren't overseen by highly paid people, but rather, track existing market indexes, like the S&P 500. As such, the fees you'll pay for index funds are substantially lower than what you'll pay for actively managed funds, and the lower your fees, the less they eat into your returns.
Keep in mind that your 401(k) will generally offer both stock and bond funds, but with the latter, you'll usually see much lower returns than with the former. If you're within a few years of retirement, focusing on bond funds is a good idea. But if you're a long way off from that milestone, you're better off loading up on stocks. The reason? You have time to ride out the market's ups and downs, and if you play it safer by choosing bonds, you may not get the returns in your account you're hoping for.
3. Consider a Roth
Not every 401(k) has a Roth savings feature, but if yours does, it pays to take advantage of it. With a traditional 401(k), your contributions go in tax-free, which is a nice way to reap some near-term savings, but then your withdrawals in retirement are subject to taxes. Roth 401(k)s work the opposite way -- you don't get a tax break on your contributions, but your withdrawals in retirement aren't taxed, and that's a huge benefit to be privy to when you're older. Also, whereas higher earners are barred from contributing to a Roth IRA, that restriction doesn't apply to Roth 401(k)s -- you can earn as much as you'd like and still fund one.
The savvier you are in managing your retirement savings, the more financial security you're apt to buy yourself as a senior. Make these smart 401(k) moves, and with any luck, you'll be sitting pretty once retirement rolls around.