Despite the fact that 18- to 34-year-olds are more likely than almost ever to live with their parents, we’ve still got to push forward with this whole “adulting” thing.
And you know what that means: saving for your future.
The easiest way to get onboard with responsible fiscal behavior is with a 401k. And if you don’t know what that is, you’re not alone! We spoke with the experts to break it down for you.
What is a 401k?
A 401k is a type of retirement plan that’s sponsored by an employer. It allows you to save and invest money pre-tax, and has the added benefit of an employer contributing alongside you.
“First timers should think about their 401k as the initial ‘engine’ of growth for their overall financial plan,” explains Robert K. Altshuler, partner and chief operating officer of Phoenix-based PlanningCore Wealth Advisors. “Unless you absolutely cannot afford to set aside any dollars whatsoever, you should contribute to your employer's 401k plan as soon as you are eligible.”
How much should I put into it?
Typically, you should invest between 3 to 6% of your salary into your 401k, but you’re welcome to contribute more than that. In fact, “If someone can get to a 10 or 12% deferral, they can virtually assure themselves of having a comfortable, adequate retirement,” notes Altshuler.
What about employer matching?
Your employer will typically match 50% of your contributions up to a certain point. That point is often around six percent, so they’d essentially contribute an additional 3% to your 6.
Is there any reason I shouldn’t enroll in a 401k?
Surprise! Contributing to a 401k isn’t for everyone. In fact, some people – such as those who are self-employed – are unable to even set one up. There are also unique sets of circumstances, needs, and goals that may prove you’re better off investing in a different kind of account.
For example, maybe your employer’s 401k plan lacks proper flexibility, has astronomical fees, or doesn’t match your contributions. Or maybe you’re swimming in debt, or living paycheck to paycheck, and need to focus on those two things for a year or two first.
If none of the above applies to you, though, the answer to “When should I open a 401k?” is right now.
“If your employer offers a plan, why wait? Especially if they are offering you a match to participate,” says Richard E. Reyes, a certified financial planner specializing in retirement income planning and portfolio allocation. “That is free money that, every day you are not participating, you are losing out on.”
Reyes says that life happens and it may deter you from contributing. But “even if, for some reason or another, life happens and kicks you in the ass,” keeping you from contributing, you have to jump back on savings bandwagon eventually.
“It doesn’t get any better the longer you wait,” he says. “I don’t care if you are 50. Get to it, and in some way play catch up.”
Alternative Retirement Plans
If you’re self-employed or looking for an alternative plan, you do have options.
Traditional or Roth IRA: If you are going to contribute $5,500/year or less. Roth IRAs consist of already taxed income, so you aren’t taxed when you withdraw. Traditional IRAs consist of untaxed income, so you are taxed when you withdraw.
Simple IRA:If you are going to contribute more than $5,500, but less than $15,000. This is designed specifically for small business and self-employed individuals.
SEP or Solo 401k: If you are going to contribute more than $15,000. This is a solid choice for business owners and their spouses who are able to set aside a significant portion of their earnings.
Questions to Ask Your Employer
1. Are there any employer matching funds?
2. How much am I paying in administrative fees?
3. How were the plan investment choices chosen?
4. How was the 401k provider chosen?
5. Who decides when it's time to remove an investment choice?
If you leave your employer and/or need to roll over your 401k into a new plan, first decide where you want to roll it into (e.g., IRA, new employer 401k). Research any tax penalties you may incur from rolling over. Next, set up the new account and initiate the rollover.