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401鈥� what?

No shame if that鈥檚 the first thought that comes to mind when presented with this benefit at your first job post-graduation. It鈥檚 named after a section of the tax code, and the IRS could鈥檝e saved us all a lot of grief by calling it what it is: an employer-sponsored retirement savings account.

The beauty of a 401(k) 鈥� and why you should listen up when you get to this part of your job orientation 鈥斅爄s that it allows you to send money directly from your paycheck into that investment account, before taxes are taken out. Better still, at least a portion of those contributions are likely to be matched by your company. (Another name for that: free money.)

If you鈥檙e offered one of these accounts, you should take it. Getting the retirement-saving ball rolling not only聽聽鈥� the earlier you start, the more time your money has to grow 鈥� it also begins the process of turning saving into a habit. On the flip side, the longer you put it off鈥� the longer you鈥檒l put it off.

The basics of a 401(k)

There are a few things you need to know about this kind of account. Your contributions are earmarked for retirement, and because they鈥檙e made pre-tax, the IRS holds them with a tight grip. In most cases, you鈥檒l owe a 10% penalty and income taxes if you pull the money out before age 59陆. But if you make it to that finish line, you鈥檒l have a pot of money that has grown tax-deferred; when you make withdrawals, called distributions, that money will then be taxed as income.

Don鈥檛 let that penalty scare you, says Brian McCann, a certified financial planner and founder of Bootstrap Capital in San Francisco. 鈥淥ne fear people have is that they鈥檒l need the money. That鈥檚 a valid fear, but if your company offers a match and you鈥檝e invested up to that, unless your tax rate plus penalties is above 50%, you鈥檒l still walk away ahead鈥� if you have to tap the account early.

That doesn鈥檛 mean you should dip into the account, and it assumes your employer鈥檚 matching dollars are vested, which means the money is yours, even if you leave your job. Some companies offer their match on a vesting schedule that requires you to stay a certain number of years to keep that money. (Money you contribute from your paycheck is always yours; if you leave a job, you can聽, or your next employer may allow you to roll the money into a 401(k) plan there.)

A standard employer match is 50% or 100% of your contributions, up to a limit, often 3% to 6% of your salary.

Deciding how much to contribute

You may feel like you have a lot of drains on your budget: Student loans, for example, plus the burden of managing monthly expenses on your own for what may be the first time. You now know why your parents stressed turning out the light when you left a room.

But a 401(k) contribution should be factored into your budget just like any other expense, and in most cases, it should be prioritized before paying extra toward student loans, McCann says.

鈥淚f you can earn more investing than you鈥檙e paying in interest on your loans, make minimum payments on the loan, then max out your employer match to your 401(k). An employer match is a 100% return, and you don鈥檛 get that anywhere, so it鈥檚 silly not to take it.鈥�

So that鈥檚 the first guideline. Once you鈥檝e captured that match, you can direct additional attention toward your student loans, or you can聽聽and continue investing there, where you鈥檒l have a wider investment selection, potentially at a lower cost. (An IRA can be your first stop if your employer doesn鈥檛 offer a retirement plan.)

Choosing your investments

That baby face isn鈥檛 the only benefit to being young: You can afford to take more investment risk, which means you can put the bulk of your money toward stock or equity funds.

Funds hold a basket of investments, so you鈥檙e not selecting a single stock or bond, but rather hundreds of them in a certain category. A U.S. large-cap fund, for example, will hold the stock of large companies in 鈥� you guessed it 鈥� the U.S.

In general, 401(k)s offer a tight set of investment options, maybe 10 to 20 fund choices. Some will have high expense ratios, which is another term for the annual fee charged to investors by a mutual fund. These can range from below 0.10% to 1% or more: A 0.50% expense ratio means you鈥檒l pay $5 for every $1,000 you invest.

Your goal is to keep costs low, which often means selecting index funds and exchange-traded funds over actively managed mutual funds. The former track an index 鈥� say, the S&P 500 鈥� without the oversight of a professional manager, which means they typically cost less. Then you want to diversify not just by industry, but globally, says McCann.

And if all of this is making you regret all those skipped economics classes? Your 401(k) likely offers a target-date fund option, which may have a higher expense ratio but is automatically diversified and designed to rebalance to take less risk as you age. Select the one with the year in the name that most closely matches your estimated retirement date, or mimic that fund鈥檚 holdings to build your own portfolio.

Finally, work up to saving more. The easiest way to do that: Increase your retirement contribution each time you get a raise.

Arielle O鈥橲hea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter:聽.

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