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My Employer Sponsors a 401k Plan – How do I Get Started? What Do I Need to Know?

You know you should be saving for retirement but it’s difficult to make it a priority when it seems so far away.  You have current financial demands – living expenses, paying down student loans, rent/mortgage, etc. and it feels like you don’t have much to contribute to retirement right now, but all you have to do is start with something!  A 25 year-old who starts saving $100 a month, with a 7% rate of return would have close to $265,000 by age 65. One of the biggest advantages that we have is time.  We have time to save and time for our money to grow.  Creating these habits of saving now will pay off greatly when you reach retirement.

 

How Much Should I Contribute?

Most employer 401k plans include a match up to a specified percentage of your contributions.  By not contributing to your 401k, you are turning down part of your salary!  Your first goal should be to take full advantage of your company match.  Your 401k contributions come directly from your paycheck.  Take a look at your expenses to see how much you can afford to contribute per paycheck and start there.  Increase your contributions one percent or more (if feasible) every year or every time you get a raise or promotion.  This will give you a schedule for slowly and consistently increasing your retirement savings as your earnings increase.

Once you are contributing enough to receive your full company match, consider increasing your contributions even more.  The maximum amount you can contribute to a 401k is $18,000 per year.  If you are approaching this level of savings, you should consider other types of retirement savings accounts such as IRAs.

 

My Company Offers a Roth 401k. What is the difference between Roth and Traditional contributions?

Contributions to Traditional 401k plans are pre-tax (you do not pay taxes on your contributions when they go into your 401k, but you will pay taxes when you take the money out at retirement).  Roth 401k contributions are after-tax (you will pay taxes now on the contributions to your plan but will not pay tax on them when you take distributions at retirement).  Roth contributions can be beneficial if you are in a lower tax bracket at the time of contribution than you expect to be in retirement.

 

How should I invest my contributions?

If you are new to investing and just getting started with retirement savings, consider using the target date fund option corresponding to your anticipated year of retirement.  A target date fund uses an investment allocation formulated to match the appropriate level of risk and time horizon for someone aiming to retire in that particular year.  As you get closer to retirement, this fund’s investment allocation adjusts to become more conservative.

 

Can I access money in my 401k before retirement?

When contributing to your 401k, you should plan on not touching this money until retirement.  There is a 10% penalty on distributions made before age 59 ½.  There are exceptions to this rule in extreme circumstances such as death or total and permanent disability but make sure that you have an appropriate level of emergency savings and insurance to help cover an unexpected need.

 

What happens if I change employers?

If you change employers, your plan may be able to roll over to your new employer’s plan, or it can be rolled into an IRA account.  To avoid any early distribution penalties make sure that the transfer is a direct rollover from plan to plan or plan to IRA.  If the money is in your possession during the transfer process, the IRS will deem it to be a premature distribution with a 10% tax penalty.  To avoid this penalty, seek help from a financial advisor during this process to ensure that the rollover is completed correctly.

 

Although retirement may seem so far into the future and you may feel like you would be better off waiting until you have more to contribute, the earlier you start, the better.  The longer you wait, the more difficult it will be to accumulate enough savings to support your retirement years.  Get started now and let your money work for you. Your retired self will thank you. 

 

 

Investment returns cannot be guaranteed. All investing involves risk, including the potential for loss of principal. Opinions expressed above are those of Treybourne Wealth Planners and are not individualized investment, tax, or legal advice. 

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