In a world of odd acronyms, learning about retirement savings accounts can be overwhelming, and well, boring. 401k, IRA, Roth IRA, 403(b)…… the list goes on. At the end of the day, there’s an endless amount of knowledge you can attain and research you can do. Gone are the days of pension funds (unless you’re a fireman or police officer, essentially), where employees really didn’t have to worry about this sort of thing- their employer stashed funds away for them in exchange for a promise to send them a nice check each month in retirement. (That’s where your grandpa gets his gambling money from). If you worked long enough for a company with a pension, you essentially guaranteed yourself of sustaining your standard of living in retirement. These days are over. Our generation must take responsibility for our own retirement well-being, which can be scary. However, this added control of your assets can also be extremely rewarding and lucrative. Set yourself up for country club tee-times, a nice cadillac, and mai-tais on the beach by getting informed now about something you’re going to really, really care about one day- your 401(k). Wait too long, and you could be clipping coupons and just hoping to play the municipal course a couple times per year.
401(k) or 403(b) – these are essentially the same thing, it’s just that if you work for a hospital, school, or other similar non-profit organization it’s called a 403(b). The rest of the world deals primarily with 401ks. They are “employer-sponsored,” which for you just means they are operated via your employer. If your employer doesn’t offer a 401(k) or 403(b), you don’t get one. This is one way they are different than an IRA (Individual Retirement Plan), which can be opened by almost anyone that has a job and have nothing to do with your employer.
Pros:
- The part of your paycheck that goes into your 401(k) doesn’t get taxed, yet. This means it gets to grow and compound without a tax impact (until you are old and grey).
- You can make money in your sleep. Compounding interest is a beautiful thing and rewards those that start early and have time on their side.
- Your contributions don’t count towards your taxable income. This helps lower your taxes and offset some of the cash-flow “downside” to saving money.
- If your employer has a “matching” feature, they will match a certain percentage of your contributions. More on that to come.
Cons:
- In 2018, the limit you can contribute is $18,000
- Less cash flow on-hand, since you are saving.
- You can’t pull the money out before you are retired (or you switch employers) without a penalty. As long as you are an employee at the company, the money stays in the plan. (there are a few things, like medical emergency or hardships, that allow you access to the funds penalty-free)
- When you withdraw the money (when you are old and grey) it will finally get taxed
Common Questions:
How much should I contribute?
- If your employee has a “matching” feature, always contribute enough to receive the entire match. It’s free money, don’t pass it up! (example: if your employer matches 4% of your first 5%, always contribute at least 5%!)
- Beyond that, 10% has traditionally been the rule of thumb. After you do a monthly budget, you should arrive at a number that you’re comfortable putting away.
How Is the Money Invested?
- Your employer will often give you a few different options for how the money is invested (how aggressive it is in terms of stocks vs. bonds). The younger you are, the more aggressive you should be. To be more aggressive, allocate more to equities (stocks). 80/20 or 90/10 equity to fixed income ratio is appropriate for most in their 20’s and 30’s.
When do I get the money?
- When you leave your employer or retire, you can withdraw the funds. You have a few options- you can roll the funds over to your new employer’s 401(k) plan, you can roll the funds into an IRA (article coming soon on these), or you could receive a check. There are some tax consequences depending on the option you choose, but just know the money is yours!
It can be scary to voluntarily give up control of thousands of dollars each year. Your employer should keep you updated on how the account is performing (will depend largely on the stock market and economy) and you can watch your nest egg grow and grow. The most important thing is to get started early. Compounding interest is a beautiful thing, and getting started in your 20’s with a moderate savings each month can vastly outperform someone in their 40’s trying to play catch-up.
There are a ton of different variations on 401(k)s and different features that employers can offer. Don’t be embarrassed if you don’t understand the fine print- ask questions. Your employer is required to provide materials that explain the 401(k) plan and all that you’re signing up for. Chances are, most of your co-workers don’t know the ins-and-outs of the plan, either.
Have a great week,
David
MoneyStuff 