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Let’s talk about the most basic, traditional way to save for retirement: through your company’s 401k plan.
Actually, before I begin, I’d like to acknowledge the fact that a lot of small businesses don’t offer 401k plans. In fact, 14% of employers countrywide do not offer employees a 401k or other defined contribution rate. Isn’t that crazy? So if that’s you, get a new job!
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If you’re one of the lucky ones who have a 401k plan, I have news for you: 66% of Americans aren’t taking advantage of it according to Bloomberg. Please DO NOT be the majority here. If your employer doesn’t offer a 401k, you should probably go look for a job that does. In my opinion, it’s really not worth working somewhere that doesn’t offer a 401k plan if you can help it. If you see a job posting that’s very similar to your current position or know someone who can get you in somewhere that offers a 401k plan, take it.
A brief history of the 401k plan:
Contrary to popular belief, the 401k is not a retirement strategy. The first 401k plan was born in 1980. I don’t care what that article says or what anyone else says, it is not a retirement plan.
The 401k was initially a savings plan meant to supplement your pension. In other words, it was a nice bonus you provided yourself but was not necessarily as important back then as it is today. Your pension gave you the cushy retirement you always dreamt of.
These days only 4% of companies in the private sector offer a defined benefit pension plan.
Even for me, last year, the company I work for froze their pension plan. I hadn’t worked there long enough to received a vested amount so I wound up with nothing. Wah. So I learned firsthand how important it is to be on top of your 401k benefits.
So what to do?
Ideally, as soon as you start your job, you need to find out what the deal is with your 401k. The good news is, over 1/3 of millennials are saving at least 15% for their 401k. The craziest thing I’ve seen at work is a lot of people don’t even pay attention to their own plans and these people are 35 years or older. It’s insane.
Actually, even worse, I remember my job prior to this, a guy at work checked his 401k for the first time and was totally shocked at how much he had saved and didn’t even realize the percentage of his salary he was contributing until then. He’d been working there for 10 years. I was like dude are you kidding me right now, one of the few reasons I’m here is to save for retirement.
You will want to check if your company has a contribution plan or “matching” plan. I can’t tell you how many people I hear at work contribute below this amount. Basically, a matching plan is free money. Your employer will match a certain percentage of your own contribution up to a certain amount. For example, my employer automatically contributes 4% and then matches 50% of my contribution up to 6%. So if I were to take full advantage of this, which I do, I am automatically putting away at least 13% of my salary away for retirement.
And to further prove my point how much people are missing out:
58% of Millennials Are Saving For Retirement Via Investing Account; $26,475 is Average Amount Saved:
I’m 29 and I have over $80,000 saved just in my Roth IRA and Roth 401k. That means all of that money will grow for another 35 years at least, and I’ll be able to use it tax-free since it was already taxed when I saved it. This isn’t even considering the $46,288 I have in my separate brokerage account.
You’re going to need to boost your retirement savings if you want to be able to retire on time if you’re like the people in the chart above.
It’s incredible almost half of those working don’t participate in a 401k. You will never be able to retire without compound interest working for you. What’s even worse, for those who have a salary of $49,999 or less, 66% aren’t using a 401k to prepare for retirement. That’s not good considering those are typically recent grads or those in their 20’s who have the biggest advantage of time on their side to take advantage of compound interest. You have 40 years ahead of you, use the 401k retirement plan.
You always read if you really want to retire sooner than most, contribute at least 20% if not more, so my goal is to annually increase my amount.
You will always want to make sure you are on top of your 401k. Sometimes companies will change their policies regarding the matching program and you may find yourself unaware of the change for a few months or worse, years.
My advice would be to check your 401k amount and the company policy once a year. More than that is redundant and may drive you crazy obsessing over the amount, where to invest the money, etc. Just let it be. The less you do, the better.
When you receive a raise or get promoted and your salary increases, always raise your contribution rate. If you get a raise, contribute the entire amount of the raise. If the increase is through a promotion, use your own discretion, but I highly advise to save the difference until you max out your 401k if you haven’t done so already. If you’re already maxing out your 401k, open a brokerage account and set up a Roth IRA or IRA depending on your salary.
The maximum amount you can contribute under the age of 55 is $18,000 (18,500 for 2018) with an additional catch-up limit of $6,000. Please, please, please don’t even let it get to that (the catch-up limit). Don’t find yourself having to rely on an extra $6,000 contribution down the line. You don’t have nearly as much time to let your money grow.
You can click here to see how the rules affect you.
The pretty cool thing is in most cases, you have the ability to choose your investment plan within the 401k plan. One option I have seen at my previous job is target date funds. This essentially means your money is allocated a specific way according to the number of years you have left until retirement. For example, if the target date is 2055 your mix will probably be much more heavily invested in stocks than bonds because historically they bring the most growth to your money.
As you get closer to the target date, your portfolio will be more and more conservative with bonds increasing in percentage of your portfolio to protect you from a loss in the market. I personally do not agree with this method, because stocks perform better than bonds and it makes no sense to waste money on 3% performance when you can get an average market performance of 7%.
Another way to choose where your money goes is through mutual funds based on risk tolerance. There are mutual funds consisting of small-cap stocks, some only in blue chip stocks and others say in international stocks. I don’t have much to say about these, except to stay away from them. The fees are usually too high and certainly don’t justify the returns produced by them.
The last and my personal favorite method of investing 401k money is through index funds. Index funds are mutual funds that are designed to literally match or track an index such as the S&P 500 or the Russell 2000 index. The idea is that an index mutual fund provides broad market exposure by owning a little bit of each stock in the index. These funds are passive and do not require active management so the fees on these funds are extremely low. Almost no active managers have beaten the market in the last 15 years.
My story with 401k plans:
When I started my first job that provided 401k plans, I just let it automatically enroll me in whatever plan and default rate they set my contribution to. It was like 3% or something I honestly can’t even remember. When I left that job my dad was like “so did you transfer your 401k savings to your new job?” I was like, what are you even talking about?” I had no idea you were supposed to transfer the money into your new plan at your new job let alone even knew that was possible.
After that little incident, I decided to learn as much as I could about 401k plans. My dad told me to first and foremost find out if there was a matching plan, and if there was, to set my contribution to at least that amount since it’s free money that I would be getting from the company.
While that was all well and good, I still didn’t know you could determine how your 401k money would be invested.
The next job I took, where I am now, fortunately nearly doubled my salary. I was able to max out my 401k limit since I was living at home. I researched everything there was to know about the plan: what the matching rate was, what types of funds were available, how often I could change the rate, etc.
Within a span of two and a half years, my 401k went from $0 to $30,000, and that’s not even including my Roth IRA or brokerage account. I’m telling you, when you get out of school, DO NOT move out right away unless circumstances otherwise force you to. There is no rush and you will thank yourself down the road.
Recap how this applies to you:
1. You can save just as much if you put enough focus and effort into it. I live in the New York City area and am participating in my 401k plan, and I’m sure there are some of you reading this who do not live in one of the most ridiculously expensive places in the country, so get saving and investing
2. If you haven’t done so, ask HR or someone reliable ASAP who you know would be willing to assist you with getting more information about your 401k plan
3. Decide how much to save, and automate it. When the amount is directly taken out of your paycheck, you’ll forget what it was even like to have the extra cash
4. Pick your investments if possible. Sometimes the fund you are automatically put in is not the best fit
5. Research the fees associated with your investment plan. It may not seem like a lot, but fees at 1% or greater will destroy your net worth in the long run
On that note, I hope this answered some questions you may have had on 401k plans.
Always make sure you’re taking full advantage of the 401k and matching plans. You will not reach retirement at your preferred age if you don’t.
If you have any more questions or comments, please feel free to drop them in the comments section below!
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