7 rules for a successful 401(k) retirement account

401(k) egg in a nest on grass

Sign up today. That's the single most important piece of advice we can give you about a 401(k) plan offered by your employer.

We can't guarantee that the plan will build all the retirement savings you want. The ultimate value of your 401(k) depends on many things — how much you save, how long you have before you retire and how well the stock market performs over that time.

But we can guarantee this: Some savings will always be better than no savings. You'll be incredibly grateful for every dollar you set aside.

Our 7 simple rules for a successful 401(k) account can help you do as well as possible by making the right decisions about your retirement plan.


Rule 1. Choose a Roth 401(k) account if it's available.

Contributions to a traditional 401(k) plan are tax-deductible. The money you put into a Roth 401(k) is not.

But when you retire, none of your Roth 401(k) withdrawals are taxed, including all of the money you'll earn from capital gains (the increased value of your mutual fund holdings), interest and dividends.

While taking a tax deduction now may seem like the better choice, most families don't save that much by deducting 401(k) contributions.

We're talking about $375 for a family of four making the national median income of $53,891 a year and contributing $2,500 to a traditional retirement plan.

You should be better off avoiding taxes on your earnings, which, after years of growth, will account for the majority of the money in your 401(k) account.

This is a particularly wise choice if you're in your 20s and 30s.

Since you're not making nearly as much as you likely will later in your career, your contributions are taxed at a relatively low rate, and your earnings will never be taxed — no matter how much your income might grow in the future.

If your company doesn't offer a Roth 401(k) account, go ahead and open a traditional 401(k).

The key thing is to start saving for retirement now.

If your company eventually adds a Roth 401(k), you can switch all future contributions to it. Your past contributions will remain in the traditional 401(k) and continue growing until retirement.


Rule 2. Start small and gradually increase your contributions.

The major reason employees don't take part in 401(k) plans is an understandable reluctance to have more money withheld from their paychecks.

So start small, even as little as 1% of your pay, if necessary. You'll hardly notice 1%. We promise.

If you're contributing to a Roth 401(k), every dollar you contribute will be a dollar less in your paycheck.

But since traditional 401(k) contributions aren't taxed, every dollar you put into your account will cause your take-home pay to fall by only 65 cents to 90 cents.

If you're making $40,000 a year, contributing 1% percent of your salary adds $8 a week to your retirement account but only reduces your paycheck by $7 a week.

You know you can manage without that $7, especially when it's going to amount to much more down the road.


When to start collecting Social Security


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Rule 3. Go for the match.

Do you like free money? That's what any 401(k) matching funds your employer provides amount to.

Laws governing 401(k) accounts encourage employers to match the first 1% of your savings dollar-for-dollar and then contribute 50 cents for each additional dollar you save up to 6% of your annual earnings.

That's an extra 3.5% you could be earning every year.

If you start by putting just 1% into your plan, you could gradually increase your contribution by another 1% every month. Too fast? How about an extra 1% every six months or even every year?

Just make a plan and stick to it. You may be able to sign up for automatic increases, so you don't have to call or submit a form each time you want to boost your savings.

Your ultimate goal should be to keep pushing your contributions up until you're saving 12% to 15% of your income in your retirement fund.

Studies show you'll need to save at least that much, over a significant number of years, for a comfortable retirement, especially if your 401(k) and Social Security will be your only sources of income.


Rule 4. Put your money into a target-date fund.

Another reason employees fail to sign up for a 401(k) is that they worry they'll make a mistake in investing their contributions.

Most plans require you to put your money into a mutual fund, a type of investment that pools the savings of tens of thousands of people to buy a broad range of stocks, bonds or both.

Many plans let you pick from a lot of different options, but you don't need to feel overwhelmed — just pick what's called a target-date fund or life-cycle fund.

That's as simple as choosing the one designed for the approximate year you plan to retire. (That date will be right in the fund's name.)

The managers of these funds take greater risks with your money when you're young, buying a mix of stocks and bonds with the most potential to increase in price and boost the value of your 401(k) account.

Of course, those kinds of investments are the most likely to tumble if the market falls. But there's plenty of time for the market and your retirement savings to rebound.

As you age, life-cycle funds adjust their mix of stocks and bonds to take fewer risks and ensure your money is there when you retire. Your money may not grow as fast at the end, but you'll have peace of mind knowing it'll be there when you need it.


penny on a fever line

5 things to know about target-date funds


Target-date funds can make investing easy. Rather than picking stocks and bonds on your own to create a diversified portfolio, you select a single fund designed to have the right combination of assets based on when you plan to retire — your "target date." Here's how to buy with confidence.



If your retirement plan doesn't offer a target-date or life-cycle fund, invest in a mutual fund that buys shares in all of the companies represented in a widely watched index of how the stock market is performing, such as the Standard & Poors 500.

These index funds don't try to beat the market — a risky bet, at best. They buy a broad range of companies based on the evidence that stocks, as a whole, become more valuable over time.


Rule 5. Buy mutual funds with the lowest fees.

Fees can be a relentless drain on retirement accounts, holding down gains when the markets are up and accelerating losses when stock prices are falling.

The lower the fees, the more your 401(k) is likely to make for you.

A good rule of thumb is to never buy a mutual fund that charges more than 1% a year.

Most target-date and index funds charge much less than that. Vanguard Target Retirement Funds, for example, charge only about 0.17% a year.

If you have a choice between target funds from established companies, go for the one with the lowest fees.


Rule 6. Watch but don't touch.

Mutual funds are long-term investments. You have to be patient.

You're in this to build wealth over the next 30 or 40 years, so don't fret over the daily ups and downs of the market.

Revel in the gains, but don't panic over the losses — and, above all else, don't sell your mutual funds during a downturn.


Rule 7. Don't borrow against your 401(k).

Yes, it's your money. And, yes, you can borrow against it.

But money you borrow from your 401(k) is no longer working for you and your retirement, and you have to figure out a way to pay it back within a specified time, usually five years.

That's right: Even though you've borrowed your own money, it must be paid back.

Those loans can't be repaid through pretax payroll deductions. You must reimburse your retirement account with post-tax cash from your checking or savings account.

If you don't do so, your loan will be considered a premature distribution — and a premature anything is usually bad.

In the case of your 401(k) account, money withdrawn before you're 59½ incurs a 10% penalty, and you must pay state and federal income taxes on the amount.

Also, if you want to change employers, you have to pay back any loans against your 401(k) before you leave your job. If you don't, your loan will automatically be considered a premature distribution.