You probably understand the basics of your 401(k) by now: You defer a portion of each paycheck. It gets invested, and then you sell those investments, hopefully at a profit, when you need your money later. Once you set up your paycheck deferrals, you can pretty much forget about it until retirement -- but that doesn't mean you should.
If you ignore your 401(k), you're missing out on valuable opportunities to build your wealth more quickly. You need to do these four things if you want to maximize your nest egg's growth.
Image source: Getty Images.
1. Claim your 401(k) match
Your 401(k) match is money your employer contributes to your 401(k) if you make contributions yourself.
Each company sets its own matching formula. Some offer a 100% match where your employer contributes a dollar for every dollar you contribute, up to a certain percentage of your income. Others have a 50% match, where your employer gives you $0.50 for every dollar you contribute. And some companies have a tiered system, where you get a 100% match up to a certain percentage of your income and a 50% match on another percentage of your income after that.
Your match could be worth thousands of dollars today and possibly tens of thousands of dollars by retirement, so it's worth prioritizing every year if you can. Check with your employer to find out how much you have to set aside each year to get the full match. Then, divide that by the number of pay periods to figure out how much you must defer per paycheck. Don't forget that you may need to increase this amount in the future if you get a raise.
2. Increase your contributions annually
Ideally, you'd save at least 10% to 15% of your income for retirement each year, but that's not always feasible. In that case, start with what you can for now, and aim to work up to that slowly. One way to do this is by bumping your contributions up by 1% per year. If you make $60,000 per year, that comes out to $50 more per month.
You can also increase your contributions whenever you get a raise. You could either set aside the entire raise or a portion of it. Just make sure to do it shortly after the raise takes effect, before you get used to spending all that extra money.
3. Consider a Roth 401(k)
Roth 401(k)s are similar to traditional 401(k)s in terms of contribution limits and investment options, but they're taxed differently. Contributions you make to traditional 401(k)s reduce your taxable income today, but then you pay income taxes on the money when you take it out later. Roth 401(k)s don't give you any upfront tax breaks today, but you can withdraw your money tax-free in retirement.
Not all companies offer Roth 401(k)s, but if yours does, it's worth looking into. If you think your taxable income will likely stay the same or increase in retirement, you could save a lot of money by paying your taxes upfront with a Roth 401(k).
4. Choose low-cost investments
Your 401(k) likely gives you a selection of mutual funds or exchange-traded funds (ETFs) to choose from. These diversify your savings among many stocks, so you shouldn't have to worry about any single stock weighing too heavily on your portfolio. But sometimes, these investments have high fees that can eat into your profits.
Consider investing in an index fund instead. These are funds that mimic the performance of an investment index, like the S&P 500. They typically have low fees, and they can still offer great diversification and strong returns over time.
These steps don't have to take up a ton of your time. Schedule an annual review for yourself where you look at how much you're contributing per paycheck and what you're investing in. Decide if you want to make any changes, and then give yourself permission to forget about your 401(k) until the next year.
