August 18, 2010 Leave a comment
As requested, this article will be about a 401k. I will explain what a 401k (to the best of my knowledge):
- What a 401k is
- The Pros
- The Cons
- Why start now?
A 401K is basically a savings plan structured specifically for retirement, but a 401k is not just a savings account, it is an investment account. The money you put into a 401k will grow (and shrink) with your investments. Many accounts give you multiple investment options, while some invest it automatically based on how long you have until retirement. The longer you have the more aggressive (higher risk), your investments will be. Obviously as you approach retirement you will not want to be risking your savings. But when your young, higher risks equals higher reward.
Most of the time, the contributions you make to your 401k are pre-tax income. This means the government can not tax this money (until you pull it out for retirement). In most cases, your income tax will be substantially lower when you are retirement age, therefore saving you money. This also means if you are putting 5% of your paycheck into your 401k it will seem more like 4% (give or take) or less because you lose less money in taxes (I hope this is making sense).
Most Employers, match your contributions up to a certain percentage of your salary. My employer it is 5%, so I make the maximum 5% contribution. That means if I am putting $75 out of every paycheck into my 401k my employer adds 75$ too. It is basically free money, and other than the limits employers place on matching (differs in every company) there is no catch.
Contribution Matching: Let’s just say you deposit 5% of $15,000 a year for ten years and your employer matches it. that is $7500, for free, over ten years. Also consider, as your life goes on, you graduate college, get a promotion, etc Your income increases and 5% of your income will go up, making your employers contribution amount go up as well. There is no other investment vehicle in the world (401k employer matched), where you automatically make money on your investment(some employers match half, three-quarters, or a scale that escalates with years of service).
Tax Break: You pass the taxes off until retirement, that gives your money a longer time to grow unhindered. Some states have lower income-taxes so planning your retirement can save you money that the government was going to take. Obviously, this can vary greatly, but honestly looking at my paycheck I noticed I didn’t lose near as much once I started my 401k as I thought because it was pre-tax.
Automation: We are not always strong-willed when it comes to saving money, having the money automatically deducted is like it was never there, you won’t be tempted to spend what you can’t touch.
Security: Your future is probably more important than the now. College is amazing, but for me personally I am way more excited about life after college. If I prepare for my future now, it is less of a burden later.
Investment: Stock market investments are a gamble to some degree. You can invest in hundreds of different ways from ultra-conservative to aggressive. You can lose money in your investment, but at the college age it isn’t enough to warrant worry (most of the time). Like I said previously, you can change your investment strategy as you age, but investing in low risk at my age with as little money as is in my retirement… is a waste of potential earnings (MY OPINION).
Overwhelming: ”Investing that sounds like a lot of work” or “I don’t have a clue about investing”. It can be a lot at first, but most of the time 401ks are with some kind of financial management service that will take care of all of the investing, if you so choose. Some people refer to 401ks as “investing on autopilot.”
“This sounds great when I’m older, but why now?” I was hoping I would ask myself this question! Here is some info from http://www.practicalmoneyskills.com
Timing is Everything
The sooner you start saving for retirement, the faster your account will grow. Conversely, the longer you wait to get started, the harder it will be to catch up. Some experts say that for every five years you delay getting started, you may need to double the amount you must save each month to reach the same level of income at retirement.
Here’s a hypothetical example: Say you contributed $5,000 a year to a 401(k) for 10 years – assume that your investment earned 8 percent a year and all investment earnings were reinvested in your account. Depending on how old you were when you made those contributions, you would see wildly different amounts at age 65 when you retire:
- If you started saving at age 25, stopping at age 35, when you retire at 65 your account would be worth about $787,000.
- If you started saving at age 35, stopping at age 45, it would be worth about $364,000.
- If you started at age 45 and stopped at age 55, its value would be only about $170,000.
- And, if you waited to start saving until age 55 and contributed until age 65, you’d only amass about $78,000.
These examples assume that you only invest $5,000 a year for 10 years and then stop. If you were to contribute that amount consistently from ages 25 to 65, you would amass more than $1.35 million during those 40 years. And, remember, these estimates don’t even factor in employer-matching contributions, which would make your account grow even larger – and faster.
One thing to try is a 401k calculator, now input your current numbers for what you make all that and your current age. I used 8% return (there is no magic average it varies greatly) and I did not add an annual salary increase. Then I switched my age to 40 instead of 19. The difference was in somewhere around $700,000 between starting now and at 40. Try it for yourself!
Discussion: Was this article helpful in understand a 401k? Did it encourage you to invest into one? Was it enough information? And as always, any questions?