***Before getting started here, if you ever have any questions or would like to learn more about your 401(k) or anything personal finance related, feel free to email me at hashtagmoneygoals@gmail.com. I’d be happy to help!***
All right, wtf is a 401(k)?
A 401(k) is a special type of savings account that invests your money and allows it to grow over time. The money you put into a 401(k) gets taken out of your paycheck before you even see it. Arguably the best part about a 401(k) is that it reduces your taxable income, meaning you will pay less income taxes. You’re basically giving yourself a raise.
How do I know if I can contribute (put money in) to a 401(k) account?
When you’re offered a job, your employer will likely tell you if they offer a 401(k) or not. If you don’t get any information regarding a 401(k), it’s ok to ask. Your employer also benefits from having your participate in a 401(k) program, because it reduces the taxes they pay as well. It’s a win-win!
How do I make contributions?
This depends on your employer. Most workplaces these days have online portals where you can select how much you want to contribute and what to invest in. Some employers might have you fill out a paper copy. It’s up to you to choose what percent of your gross income you would like to contribute.
How much should I contribute?
This one is up to you. The more you contribute, the less income tax you’ll have to pay and the more money you get to keep. I would encourage anyone to aim for contributing at least 10% of their gross income. If you want to contribute more, go for it! If you aren’t able to contribute quite that much or you love paying taxes, you can start at a lower percentage and work your way up.
At the very, very, least, check if your employer offers a match. If they offer a 3% match, then contribute at least 3%.
WTF is an employer match?
Ahh my bad, I should’ve explained that before mentioning it. To encourage employees to contribute to their 401(k) programs, employers will often offer to match your contributions up to a point. For every dollar you put in, they will put a dollar in too.
Let’s say you make $50,000 per year, you contribute 10% of that to a 401(k) account, and your employer has a 3% match. This means that you will put $5,000 into the account, and your generous employer will put another $1,500 in for you. (Thanks employer!)
The key point here is that you won’t get that $1,500 unless you contribute at least 3%. If you only put 1% of your gross pay in ($500) then your employer will only put in $500. If you put 0% in, you get $0.
This is the most important point of the whole post, if an employer offers a matching program, contribute at least enough to get that full amount. If you don’t do that, it’s like walking past $1,000 on the sidewalk, and kicking it down the storm drain. Yet ONE IN FOUR EMPLOYEES do exactly that, and miss out on their 401(k) matching program. WTF!
What investments should I choose?
This is where things can get confusing. There are so many different funds to invest in, and it can be hard for those of us just getting started with investing. To keep it simple, pay attention to 2 things:
- It should be an index fund made up of mostly stocks. My favorite is a “Total Stock Market” index fund from Vanguard. Other companies (such as Fidelity, TD Ameritrade, and Charles Schwab) may offer similar products. If you can’t find a total stock market index fund, then an S&P 500 index fund will do just as well. Some companies offer a “Target Retirement Date Fund” i.e. you plan to retire in 2055 so you invest in the Target 2055 Retirement Fund. That works too!
- The expense ratio should be less than 0.50%. The expense ratio is how much you pay the company who runs the fund. If your expense ratio is 0.25%, for every $10,000 you invest you will pay the company $25 every year. This relatively small number adds up over time, so you want to keep your expense ratio low. Most total stock market and S&P 500 index funds will have really low expense ratios (my go-to fund has an expense ratio of 0.04%) but check to make sure!
When can I use all this money I’m piling up?
Since a 401(k) is a savings vehicle and a tax-shield for retirement, the funds are meant to only be used in retirement. To encourage this, there is a 10% penalty for withdrawing your money before you turn 60 (59 and a 1/2 technically).
While it is possible to take your money out of a 401(k) before you retire, I would strongly caution against it. Obviously emergencies happen, and sometimes you need the money now. But if you’re taking that money out to buy a new car or something similarly unnecessary, then you’re throwing tens, if not hundreds of thousands of dollars in tax savings and investment income away.
Ok cool, I got my 401(k) set up at work, contributing 10% of my gross pay into an S&P 500 index fund with an expense ratio of 0.13%. Now what?
Now go about living your life! Maybe bump your contribution up a few percentage points every now and then. Keep working hard, doing things you enjoy, and in 40 years you might just have a few million dollars sittin’ in that bad boy. Feel free to write me a thank you note when that happens 🙂 #MoneyGoals
My apologies to my dear mother for my hideous, yet abbreviated profanity. If it gets one person to set up their 401(k) it’ll be worth it mom!
(Pictured: a photo embodiment of the phrase wtf)