Is managing your 401(k) on the back burner? It may be time to turn up the heat on your retirement savings. In honor of National 401(k) Day, Jane Smith, Director of Retirement Plan Services with First Merchants Private Wealth Advisors, explains how to get the most out of your 401(k).

What is a 401(k)?

Wondering what a 401(k) is, and how you can get the most out of it? While this retirement option may seem complex, it’s actually pretty simple.

“A 401(k) is a retirement savings account typically offered by your employer,” Jane explained. “You sign up to have a certain amount – typically a percentage – deducted from your paycheck and put into the account. Many employers will offer a ‘match,’ meaning they will contribute that same percentage amount – so you can get double the savings.”

Usually, you can select one of two 401(k) varieties – a pre-tax option and a Roth after-tax option. A pre-tax 401(k) means your contributions will not be taxed before they are put into your 401(k) plan. While it means you can put more aside early on – and benefit from the increased compounded interest – your post-retirement paycheck may take a hit if taxes have increased.

A Roth 401(k) means that your contributions are taxed before they’re added to your 401(k) plan. While you’ll see a little less going into your bank account each paycheck, it means you don’t have to pay taxes when you withdraw your funds after retirement.

“One option isn’t necessarily better than the other,” Jane shared. “It’s really about your personal preference and your own retirement goals.”

Why consider a 401(k)?

“It’s a simple way to save for retirement,” Jane explained. “The deferral amount comes out of your paycheck before that money hits the bank, and many employers will match funds. That means, essentially, you can get ‘free’ money going into retirement savings – and that really adds up over the years.

“And really, there’s no better way to save for retirement, unless you happen to inherit a large sum of money from a distant relative,” she added jokingly.

A 401(k) is also a type of retirement savings that can move with you if you change jobs. It’s easy to roll over your balance into a new employers 401(k) plan, or into an IRA – meaning your savings are not dependent on your job. So, no matter what the job market throws at you, you can rest easy knowing that your future is secure.

Can I afford to contribute to a 401(k)?

While some may balk at the idea of paring down an already thin paycheck in order to put funds in a 401(k), Jane said they shouldn’t worry.

“I like to tell a story about my oldest daughter, who got a part-time job in college,” she shared. “One day, she brought home a 401(k)-enrollment booklet and said ‘Here, they gave this to me at work. I don’t know what it is, but I don’t want to join because I worry I won’t be able to pay my rent.’ I convinced her to start contributing 1 percent of her paycheck and promised that, if she ran into financial trouble, we would make sure her bills were paid.”

“After a few months I brought up the plan again – she said she didn’t think anything had happened with it,” Jane continued. “So, we looked at her paystubs and, wouldn’t you know, they were deducting the 401(k) per our request – she had been able to pay all her bills and didn’t even notice the difference! But it meant she started saving for her future at 19 and will be financially secure when it comes time for her to retire. It goes to show that, even if you’re strapped for cash, it’s so easy to start saving – even if circumstances mean you have to start small. Over time, that little bit will make the world of difference.”

Because 401(k) contributions are taken out before the money hits your bank account, many people won’t even notice the difference – especially if the contribution is small. Jane said she told her daughter – and all her children – to start with a 1 percent contribution. Then, if they were able, to increase it by an extra percentage point every year, or whenever they got a boost in pay.

When should you contribute to a 401(k), and when should you not?

There are very few scenarios in which contributing to a 401(k) is not a good idea, Jane said.

“A 401(k) is nearly always a good option,” she said. “Especially if it has employer matching. The only scenario I can think of where it may not be the best choice is if that particular plan has expensive fees, no Roth option, no employer match, and poor investment options. And even then, I would just say don’t go with that plan – but do find a solid retirement or investment solution outside of your employer.”

As for when to begin contributing to your 401(k), Jane was firm.

“As soon as possible,” she said.

For example, she explained, a 25-year-old that begins saving at 8 percent – roughly $142 a month, or $68,160 throughout their career -- will accumulate $500,000 by age 65. But someone who waits to save until they are 35 would need to put aside $333 per month for the same result. By 45, that number is $844 per month.

How much you choose to put back is really up to you – and Jane recommends writing down your retirement goals to help guide you. Do you want to stop working completely? Work part-time? Do you plan to have all your debt paid off? These things can inform you on how large a percentage you should put back each paycheck.

What’s the payoff of using a 401(k)?

The payoff for using a 401(k) is easy – it’s reliable income at retirement that won’t disappoint.

“I think young people today need to ask themselves, ‘Will Social Security be there for you?’” Jane said. “While it most likely will, as of June 2022 the average Social Security check is around $1,542.22 per month. Is that enough to pay all your expenses? Will it be enough when you are older and ready to retire, and inflation has increased the cost of living? Add to that the fact that people are living longer and it becomes really important to ensure you have enough to see you through your golden years.”

She added that Social Security checks are designed to supplement existing retirement – not be your only source of income.

“One of the absolute best ways to ensure you have what you need to retire is to contribute to a 401(k),” Jane said. “And the earlier you begin saving, the easier it is – because time and compound earnings will do the ‘heavy lifting’ for you. I’ve met so many people preparing for retirement in my more than 30 years in this field. I’ve yet to have anyone tell me that they have too much money saved for retirement. Usually, I hear, ‘I wish I saved more when I had the chance,” or, “I wish I started saving earlier in my career."

Secure Security

A 401(k) can also provide a bit of financial security if you fall on hard times.

“While it’s not recommended, you can borrow or withdraw from your vested 401(k) balance in certain situations – such as if you need a down payment for a primary residence, have an emergency medical expense, or are the victim of a natural disaster,” Jane said.

In these cases, you’re borrowing money from yourself – so there’s no credit check required.

“It’s a good shoulder to lean on when times are hard,” Jane said. “But we do urge people to only use it for a big investment like a house, or for disaster relief and we encourage them to try and pay that money back as soon as they can so that they won’t struggle once they retire.”

Other preparations

In addition to a 401(k), there are other retirement preparations that need to be made. For example, have you arranged health insurance? Do you have beneficiaries assigned to all of your accounts? Have you drawn up a will? Is your debt paid off?

These are important things to begin thinking about – even if you are a young person just starting your career. The sooner they are completed, the more you’ll be able to relax when it comes time to retire.

And, remember, the best time to start is now.

“Remember, it is never too early – or too late – to start preparing for your future,” Jane said.