WTF Is A 401(k) And Why Do I Need One?
You've heard it a million times: It's never too early to start saving for retirement. Here's how to make sure you're making your money growth as easy as possible.
For longer than I’d care to admit, I partitioned the concept of a retirement plan in the section of my brain that houses concerns about osteoporosis and ear-hair growth—things that I’ll need to be aware of eventually, but not right now.
As it turns out, I was very wrong about this, as was my assumption that other 20-somethings were vastly and similarly flippant: A recent study by Scarborough Capital Management says more than 72 percent of young people between ages 18 and 34 are investing between 1 and 10 percent of their paychecks into a retirement fund, and a number of reports indicate that they’re starting to save earlier than previous generations, which is one of the big keys to the game.
Good looking out, you guys. But in the instance that you share the prior mindset, it’s most definitely time to look into setting yourself up with a 401(k) if your employer offers it, or a Roth IRA if you’re self-employed or your employer doesn’t (more on that here).
If your employer does indeed offer a 401(k), here’s everything you need to know to get yourself set up.
Compound interest = stacks on stacks
One of the biggest perks of a retirement account comes down to every financial advisors’ favorite phrase: The magic of compound interest! (*jazz hands*)
Compound interest is when the interest on your investment starts making interest. This is significantly more beneficial than simple interest, which only applies to the principal amount, in that compound increases exponentially over time—hence the reason everyone’s harping on young people to start investing as early as they can.
The earlier you invest, the more work your money does. And retirement accounts implement said magic, which is why you should sign up for one ASAP no matter your status of employment or age.
Set yourself up for $uccess
While a 401(k) is offered through your employer, not all employers approach the benefit the same way, and asking the right questions can be the difference maker when it comes to kicking your feet up during retirement.
Josh Robbins, Chief Strategy Officer of America’s Best 401(k), recommends asking the following question first and foremost, ahead of enlisting in a retirement plan with your employer: Do you offer a match? And if so, up to what percentage of my salary?
“The match is essentially free money, so taking advantage of the full max is typically a no-brainer,” Robbins says. What is a “match,” you ask? This means that if you’re contributing to your plan, your employer will too. How much your employer kicks in will vary, but common arrangements include a 50 percent match on up to six percent of your gross annual paycheck, or a dollar-for-dollar (a.k.a. 100 percent) match on a lower percentage—more like in the 2 to 5 percent of your gross pay.
If your employer offers a match, this is an opportunity you absolutely do not want to miss out on. “This is probably the best investment return that you will get in your entire lifetime,” says Bobbi Rebell, author of How to Be a Financial Grownup.
“Say you save say 4 percent and your employer offers 100 percent matching; you actually get a 100 percent return guaranteed even, without any market gain. And that’s not counting the tax savings.”
After you’ve deciphered the logistics on your match, Robbins recommends digging into more of the nitty gritty, such as, “Do you offer asset allocation solutions that are professionally managed and rebalanced, so I don’t have to worry about it?”
In other words: Can someone show me WTF is going on and ensure I’m putting my money in the right places? If your employer doesn’t offer assistance, considering talking to a financial planner. And lastly: “What are the total fees? And does the plan offer low-cost index funds?”
“Fees will erode your returns, so make sure the fees are reasonable,” Robbins cautions. “If you want to know your current fees, you can use a free tool like this one.”
Best practice: Leave it to the automatons
The most sure-fire way to ensure you’re consistently investing in your retirement account is to take it out of your hands. “Automate paycheck withdrawals into your 401(k) on day one of your job or today, whichever is sooner,” says Rebell.
And be sure to maximize your growth potential by really knowing how your plan works. “When you do automate withdrawals, make sure to check the box that says to raise your contribution by a certain percent every year (or another time period),” she advises, so long as that’s an option for you.
“You probably won’t notice your savings rate going up, but you will be rewarded when you look at that statement.”
Take it to the limit 🎵
While conventional wisdom asserts that we should be aiming to squirrel away ten to 15 percent of our paychecks, Rebell’s approach is a little more blunt: “The goal is $18,500 which is the maximum dollar amount allowed by law in 2018—not a random percentage of your salary—so work down from there,” she says.
“If you can’t save that much each year, do the best you can but be sure to set up the automatic increase, so long as that’s an option.”
Words: Deena Drewis