So, you’ve found yourself a new job and you’re just getting started. First of all, congrats! But don’t get settled in just yet. One of the first things you need to do at your new job is figure out how to start saving for retirement. In comes your 401K.
Should I take advantage of my 401k or not?
First of all, let’s get things straight right off the bat. You need to be taking advantage of your 401K at work. No exceptions! There shouldn’t be a reason why you don’t start saving for retirement.
This is even more true now than it ever was. Past generations have the luxury of social security and pensions, but if you’re just starting to get into work then you most likely won’t be as lucky as your parents were.
Although it can be intimidating to manage your own retirement plan, you need to grin and bear it. Nobody else is going to care about you as much as you do. Sit yourself down, do some research, and figure it out. If you can’t figure it out, then go seek help! There’s no excuse for being ignorant. This is too important to not do right from the beginning.
The best advice for your 401K
1- First of all, the most important thing you can do is to start saving as early as you can, like right now. On your first day at the job you need to ask the right questions so you can do the job right. One of those questions needs to be about your 401K so you can do that right too.
Some jobs will let you start saving to your 401K right away while others may make you wait a while before you can take advantage of it. Whatever the case, you need to get in as early as possible and start saving.
What if I can’t get into my 401K plan right away?
Don’t fret if you can’t get in immediately. Instead start saving the money yourself somewhere else. Start your saving now by taking a percentage of your paycheck each month and putting it in an online savings account. If you have debt, then use the money to pay those off first. It doesn’t make sense to put money into a savings account that only pays 1% when your credit card debt is costing you much more than that.
The point is to get into the habit of saving your money early on. A good number to strive for is to take out at least 10% of your paycheck each month and stock it away in your savings. If you can afford to do more do it. You can’t “save too much” money but you can definitely save too little.
The other reason why you want to start early is because the earlier you start the faster your money will grow as it compounds over the years. Getting started in your early 20s will get you on the right track for success.
Take full advantage of the match!
2- You need to take full advantage of any company match that is available to you, no exceptions! Getting a matching contribution from your employer is one of the best advantages of a 401K. If you’re not taking advantage of it then you’re just cheating yourself. Don’t do it!
If the company you work for is offering any sort of match you should, at a minimum, make a contribution to your 401K that takes full advantage of the match. If you don’t do that then you’re just missing out on free money that you can’t get from anywhere else. Be smart and take advantage of it.
Where do you invest this 401K money?
3- So you’re stocking money away into your 401K and you’re putting in at least enough for the company match. Great! But where should you invest this money? You can’t just let it sit in there as cash, it needs to be invested. But invested in what?
If you have no idea what you’re doing and you don’t have smart friends and family that can help you then you should ask your company whether or not they have an advisor with credentials at your disposal. If you’re lucky your employer will have an accomplished advisor for you to use for free. If not, then you might do well to pay for one if you need help. You need to wisely invest the money you’re saving early on, so these initial advisor costs can be well worth it in the long run.
If you don’t want to pay for investment advice, that’s fine too, but do your research and figure out what’s best for you. Don’t just blindly pick from your investment options. A typical 401K should have a wide array of investments for you to choose from. Do yourself a favor and pick the right ones for your invest strategy and goals.
If you’re young, then you can afford to be a little more risky with your choices. When you’re younger “risky” isn’t really as risky as when you’re closer to retirement age. Go ahead and take those risks early while you can. You’ll thank yourself for doing it when you’re older.
Still, risky doesn’t mean stupid. You need to make sure you don’t put all your eggs into one basket, even when you’re playing risky. You need to have a balanced portfolio that will give you growth potential even while being in some risky investments. It doesn’t make sense to put everything into just 1 investment.
Instead, spread your investments around into a selection of funds with different asset classes (large cap, small cap, international, bonds). For example, go with a riskier international fund, but then balance it out by investing in a blue chip large cap fund.
Don’t forget about the fees
Some of the questions you should be asking about the investment options you have is what the fees are to invest. When you invest in a stock you’re going to avoid some of the fees that you may get with a mutual fund, but with a mutual fund investment you will be much better balanced.
Ask about low cost investment options like exchange traded funds (ETFs) and low cost mutual funds. Look over the fees and performance of each fund before making a decision to invest.
Is a Target Date fund right for you?
4- Consider a target date fund. What is it? It’s basically an investment that is put on autopilot from your end. When in actuality it’s anything but autopilot from an investment standpoint. These “target date” funds will adjust their stock and bond investments so that they are more aggressive when you are younger and then more conservative when you get closer to retirement. In essence, what you do is give them a “target date” for your retirement and then your investment is moved around accordingly. Without you having to do much else.
Should I pay my taxes now or later?
5- Let’s not forget about your taxes. One of the benefits of stocking money away for retirement is that it will lower your income for the year which lowers the amount of taxes you’ll have to pay for the year. That all depends on what type of 401K you use though.
You can either go with a traditional 401K or a Roth 401K. With traditional 401Ks you will lower your tax bill since you make your contributions with pretax money (so you’ll still have to pay for the taxes when you take it out during retirement). However, with a Roth 401K, since it’s funded with after tax money, you won’t get the lower tax cost benefit for the year but you will benefit when you take the money out of your retirement account since you won’t have to pay taxes on it then (This can be great in the future if you’re in a high tax bracket during retirement).
Choosing between a traditional 401K and a Roth 401K can be a bit tricky, and can be controversial when asking financial advisors which one you should choose. You’re going to have to do some math to figure out what is most advantageous to you, and that all depends on where you stand in your tax bracket for that year. It may be better for you to use a traditional 401K this year, and then a Roth 401K next year when you get a raise.
If you don’t know which one to pick then don’t freak out. Just pick one. It’s better that you start saving to either one of these accounts (traditional 401K or Roth 401K) then none at all. If you’re already plugging money into a Roth IRA then you might be better suited for a traditional 401K so that your investments are diversified among traditional and Roth type investment vehicles, however this isn’t always true.
You might be in a high tax bracket now and in that case any Roth type investments you make now will cost you your high tax bracket in taxes. Whereas if you were making a lot of money now and put it into a traditional 401K you could be saving money on taxes when you take it out during retirement when your retirement income is less than your current working income.
With this same thinking it might be wise to put money into your Roth 401K now if you’re in a low cost tax bracket now. Especially if you don’t want to do any math come tax time to figure out how much you should allocate into your IRA and Roth IRA.
Don’t think about it so much though. Whatever you choose, traditional 401K or Roth 401K, either one of these is better than nothing at all. Be smart and take advantage of them early.