- First find out if your employer offers a 401(k) plan. If it does, find out if you qualify. Some employers require you to make a certain amount of money or have worked there for a certain amount of time before you can participate.
- If you qualify, fill out the paperwork to sign up. You will need to designate how much of your income you want deducted from your paycheck. Most employers limit you to 15 percent of your income; however, this varies. The IRS limits 401(k) contributions to 100 percent of your salary or a set dollar amount that changes from year to year. Check with the IRS for this amount. You must also decide how you want your 401(k) money invested. Most plans give you a choice between stock, bond, cash and combination funds. Make your decision based on your risk tolerance and time horizon.
- The biggest benefit of participating in a 401(k) plan is the tax break. When money is deducted from your paycheck, it is taken before taxes are assessed. As a result, you will have more money to invest. Some employers also provide a contribution match. That means, for every dollar you contribute to your 401(k), your employer contributes an additional percentage. This can range from 1 percent to 100 percent. Many investors call this "free" money; howevers you are often required to stay employed there for a set number of years before you are "vested" and can access it. Check with your employer for details.
- If you have an emergency, the government allows you to temporarily withdraw money from your 401(k). This is called a "hardship withdraw." It is allowed only if you need the money for medical expenses, buying a first home, education expenses or to avoid eviction or foreclosure. Essentially, you are borrowing money from yourself and even adding interest.
- Many employers will let you keep your 401(k) money with them even if you don't work there anymore. You can also "roll over" your 401(k) money into the plan of your new employer, or into an IRA. Just be sure that you perform a direct rollover so you won't have to pay taxes. If you cash out your 401k and are less than 59 1/2 years old, you will be taxed and charged a 10 percent penalty.
- Since 401k plans are run by employers, they are only as reliable as the employer. Federal udits are revealing some employers operating 401(k) plans that are not in compliance with IRS and Department of Labor regulations. Some 401(k) plans use risky or questionable investments. Many that invested in mortgage-backed securities lost most of their value in the mortgage collapse of 2008. Always investigate your employer's 401(k) plan before joining.
