How to Set up a 401(k)?

LAST REVIEWED Jun 18 2020 8 MIN READ

By The Human Interest Team

If you’re looking for a cost-effective way for your employees to save for their retirement, setting up a 401(k) could be the perfect solution. A 401(k) allows your employees to set aside a part of their monthly paycheck. At the same time, you benefit from reduced tax bills by making employer contributions each month. Although you must be an employer to set up a 401(k), it’s well worth knowing how the 401(k) process works if you’re an employee so you can get the most out of your investment.

What Is a 401(k)?

A 401(k) is an account that holds your investment money until you retire. If you have a standard 401(k), you’ll pay pre-tax dollars into it from your paycheck. This means the money you pay into your 401(k) is tax-free.

After you pay money into your 401(k), you can choose where to invest it. You’ll have to pay tax on any withdrawals you make after you retire, but because you’ll likely be on a lower income, you’ll probably pay fewer taxes than if you had paid them upfront.

How Do You Set Up a 401(k) Plan as an Employer?

Setting up 401(k) for your small business can be easier than you might think because you can usually outsource some of the work.

401(K) vendors or service providers can take care of things like:

  • The plan document, which outlines the rules of your 401(k).

  • The adoption agreement, which allows you to customize the plan to meet your company’s needs.

  • The trust, which is a legal entity created after your plan is in place.

Customizing Your 401(k) plan

You can choose to customize several aspects of your company’s 401(k) plan. These include:

  • Whether you want to allow loans to be taken from your plan.

  • Whether you’ll allow Roth 401(k)s.

  • Whether you want to match employee contributions or contribute a fixed percentage of their salary.

You can select your customization choices in your 401(k)’s adoption agreement. Typically, the adoption agreement includes a list of checkboxes, making it easy for you to tick the features you want to offer.

Other Things to Consider when Setting up Your 401(k)

You’ll need to manage and regulate your 401(k) plan on an ongoing basis. To complete the setup process, you’ll need to:

  • Select a plan administrator, who will monitor the 401(k) to make sure it meets important deadlines.

  • Choose a Third Party Administrator (TPA), who will complete tax filings and process requests for loans or distributions.

  • Select a record-keeper, which will manage the plan’s investments, including the website you use to invest.

While this may sound like a lot to arrange, you’ll often not be required to complete each step separately. Some vendors offer comprehensive packages that include a plan administrator and a TPA. Some TPA companies also function as record-keepers.

How to Explain How Your 401(k) Works to Your Employees

Another key step in setting up your 401(k) is informing your employees about it so they can take advantage of its benefits.

You might want to have your human resources manager outline the plan’s basic framework, including things like how to set up 401(k) contributions, and how each employee can access their account. However, you’re not responsible for providing financial advice on how employees should invest their savings. In fact, you should refuse to provide such advice, since this can only be done by an external company.

You’ll also want to provide your employees with contact details for the plan administrator so they can easily make investment choices and other changes to their accounts.

How Should I Set up My 401(k)?

Only employers can set up 401(k)s. If you’re an employee, this means you don’t have to do anything. Many employers will add you automatically to their 401(k) plan when you’re hired.

If your employer doesn’t operate a 401(k), you can try asking them to set one up. A good way to do this is to tell them about the tax benefits they can enjoy if they make employer contributions.

What Happens After My Employer Signs Me Up?

Once you’ve signed up for a 401(k), you’ll need to go through a few steps to get your account running. These include:

  • Deciding how much to contribute each month.

  • Choosing where to invest your money.

  • Choosing between a standard 401(k) and a Roth 401(k).

Standard 401(k) vs Roth 401(k)

The key difference between a standard 401(k) and a Roth 401(k) is when you’ll have to pay taxes.

As already explained, you don’t pay any income tax on the money you put into a standard 401(k). Instead, the IRS will tax you when you withdraw the money after retirement.

However, you make contributions to a Roth 401(k) with post-tax dollars. As a result, you pay your taxes upfront and get tax-free withdrawals when you retire.

Setting Up Your 401(k) Investments

A big part of setting up your account is deciding how you will invest. Most 401(k) programs offer you various options for investing your money, each of which comes with its own benefits and drawbacks.

Common investment options include:

  • Stock funds, which can increase your savings over time by investing in a selection of company stocks.

  • Target date funds, which allow you to enter your date of retirement so your investments can be managed automatically.

  • Bonds/managed income, which are meant to safeguard your money but won’t give you as much return on your investment.

You might want to look at the management fee for each fund before you decide to invest in it. Some funds charge higher fees, which means you might use up part of your savings paying them.

If you’re an employer looking to set up your first 401(k) or you have questions about a specific part of the process, we can offer useful information to help. Check out our 401(k) basics for employers to find answers to common questions and problems associated with establishing a 401(k) for your business.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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