Quick-start guide to your 401(k)

Here's everything you need to know about saving in your retirement account.

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Key takeaways

  • Aim to save at least 15% of your pre-tax income for retirement annually—including any contribution from your employer.
  • If 15% is too much right now, contribute at least enough to get any match from your employer and aim to save a little bit more each year.
  • Whether you choose your own investments or choose to stick with the default investment option chosen by your employer, the key factor is investing for the future.

One of the best ways to save enough money for retirement is to start saving early in life and invest in a mix of different kinds of investments to help your savings grow over time. Using a tax-advantaged retirement account can help you do it. If you're lucky enough to have a retirement account through your employer, starting to save and invest in your 401(k)—or 403(b) for some workers—may be easier than you think.

What is a 401(k), anyway?

A 401(k) is a retirement savings plan offered by employers that gives you some tax benefits as an incentive to save for the future. Many employers automatically enroll new employees into their 401(k) and then let you opt out if you choose. Of course, you shouldn’t assume you’re automatically enrolled; be sure to find out how your employer does it.

There are 2 types of 401(k) contributions you can make: Roth and pre-tax. Contributions to a traditional 401(k) are generally made on a pre-tax basis.1 That means you get the tax break now—your contributions come out of your paycheck pre-tax, which reduces your taxable income. You pay taxes on what you withdraw from the account and any earnings that have accumulated upon retirement.

Contributions to a Roth 401(k) are made on an after-tax basis. Because the contribution is made after taxes are taken out, you don't realize the tax benefit right away. After age 59½, withdrawals of contributions and earnings are tax free.2 Any contributions made by your employer are made on a pre-tax basis, so whether you contribute on a Roth or pre-tax basis, you will still get tax-deferred benefits. Not all employers offer Roth accounts however.

To be clear, it's not just your contributions that benefit from the special tax status of your 401(k). When you invest your contributions, those investments have a chance to grow without taxes being due on earnings each year. That can help give your money a boost in terms of compound growth because you have more money available to be invested and earn a return. Compounding returns over many years can be powerful and every dollar helps.

In addition to the tax benefits, there's often another perk of saving in a workplace plan like a 401(k)—the employer match. Some companies offer to match your contribution, for instance, dollar for dollar, 50 cents on the dollar, or up to a certain percentage of your income. For example, if an employee makes a 5% contribution, the employer may match the entire thing. Be sure to contribute enough to get the entire match—it is basically free money.

If you're automatically enrolled in your 401(k), then you'll have money taken out of your paycheck and put into the account for you. It probably won't be a lot of money as the default contribution rate is typically low and may not be enough to capture the entire match. If it isn't, consider increasing your contribution amount—something you can usually do online or over the phone. Talk to your plan administrator or HR rep if you're not sure how to do it.

Choosing between a Roth and pre-tax? Read Viewpoints on Fidelity.com: Traditional or Roth account—2 tips for choosing.

How much should I contribute?

Fidelity suggests saving at least 15% of your pre-tax income for retirement. That 15% includes any contribution you may get from your employer. Beginning to save 15% of income at age 25 may help you maintain your current lifestyle in retirement. If you start later, after age 25, it may require saving more than 15% of your income depending on your retirement goal—or working longer.

Here's why: Read Viewpoints on Fidelity.com: How much should I save each year?

Of course, you're probably already juggling debt and saving for short-term goals like moving or buying a house, and just paying the bills for necessities. But retirement is also important.

To learn about Fidelity's tips for prioritizing spending and saving, read Viewpoints on Fidelity.com: How to pay off debt—and save too.

What about investing?

The act of saving for retirement, by contributing money to a retirement account like clockwork, can only take you so far. You also need to invest your money so it can grow.

If you're automatically enrolled in your plan, your money will be invested in a default investment. Target date funds are one type of commonly available default investment. They represent a do-it-for-me option that takes care of some of the details of investing for you. For more do-it-for-me options, see below.

But you may be more inclined toward do-it-yourself investing. You don't have to become a professional trader or spend your free time researching stocks to develop and implement an investment plan. Using basic principles of asset allocation and diversification—to invest in a way that matches your time frame, risk tolerance, and financial needs—will help you get on the right path to achieve your retirement savings goals.

Do it for me

Some types of investments do the asset allocation for you.

Target date funds are managed with a focus on a particular retirement year. If you’re planning to retire in 30 years, you could pick a fund with a target retirement date of 2045 or 2050. The target date fund that is aiming for the year closest to your anticipated retirement year will invest in a mix of investments appropriate for that time frame. As the targeted date nears, the mix becomes more conservative—typically by dialing back the level of stock investments and increasing investments in bonds.

Asset allocation funds allow you choose the level of stocks and bonds you'd like in your investment mix. You pick the amount of stocks you think is appropriate based on your risk tolerance, time until retirement, and financial needs. The fund will stay invested in a diversified mix of investments with that level of risk.

Managed accounts offer professional management of a mix of investments that reflects your personal risk tolerance and time frame until retirement and the investment strategy of any other assets you may have. The investments are rebalanced regularly to maintain an appropriate asset allocation. With a managed account you get the opportunity for more personalized investment solutions that can change to reflect your evolving needs and circumstances. There’s typically a fee for the service plus the cost of the underlying investments.

Do-it-yourself investing

If you think you have the will, skill, and time to manage your own investing, you should be sure that you understand the concepts of asset allocation and diversification.

Asset allocation refers to the way you split your investment mix among asset classes. Diversification is the benefit you receive from asset allocation.

If you become a do-it-yourself investor, it is important to start with asset allocation and understand the appropriate level of risk for your specific goals. The appropriate asset mix should reflect the length of time you plan to stay invested, your tolerance for volatility, and your financial situation. Once you determine how you want to be allocated, then you can focus on picking securities—being sure to pick a diverse array of investments.

Even if you choose to manage your own investments, you may not be entirely on your own. 401(k) providers often offer example investment strategies that could give you ideas on how to build a diversified portfolio. You can invest in the funds in the model portfolio in the recommended proportions or you could use the models as a source of inspiration for your own investment ideas.

Don’t be intimidated by terms like asset allocation and diversification. Read Viewpoints on Fidelity.com: Investing tips for young people.

Learn to love to save

One of the best things about a 401(k) is that it needn't require a lot of maintenance. If you're automatically enrolled in the plan it can be a good idea to check and make sure you're contributing as much as you can. As time goes on, check in and increase the amount you're able to save if you can and revisit your investments to ensure they remain in line with your risk tolerance and goals.

Because the contributions are taken right out of your paycheck, chances are you won’t even miss the money. When you do eventually retire, you’ll be thankful that you started early.

Next steps to consider

Get your Fidelity Retirement ScoreSM, a credit score for retirement.

See if you're on track in the Planning & Guidance Center.

This small percentage can add up to a lot in retirement.

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1. Some 401(k) plans may allow after-tax contributions once you've contributed up to the contribution limit.
2. A distribution from a Roth 401(k) is tax free and penalty free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, or death. A distribution from a Roth IRA is tax free and penalty free, provided that the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, qualified first-time home purchase, or death.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
Investing involves risk, including risk of loss.
Target-date funds are designed for investors expecting to retire around the year indicated in each fund's name. The funds are managed to gradually become more conservative over time as they approach the target date. The investment risk of each target-date fund changes over time as the fund's asset allocation changes. The funds are subject to the volatility of the financial markets, including that of equity and fixed income investments in the United States and abroad, and may be subject to risks associated with investing in high-yield, small-cap, and foreign securities. Principal invested is not guaranteed at any time, including at or after the funds' target dates.
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