Alright, alright! So you’ve landed that dream job…or, at least the first initial gig that involved signing an offer letter with a company that offers paid vacation, incentive, potential bonus capability & a retirement savings plan. You are overcoming that journey of the first 6 month uphill battle ‘learning curve’ that every co-worker seems to throw your way and manage to keep it together (even if it means getting off work and crashing at home on the couch/bed/floor barely having the ability to function and intense effort is even required to lift your phone or watch TV). You’ve got a great thing going & you are feeling confident with each passing day in the workplace. You’ve taken the immense leap into this mythical corporate world that seemed eons away while you were pursuing your undergraduate degree (side note: there were also the graduates who took the route of traveling abroad, pursuing a Masters, becoming an entrepreneur, etc.– even if the mentioned scenario above isn’t applicable, the main point of this blog shall be a consideration for the future).
Now 90 days have successfully gone by in the office (you Rockstar, you!) and all of the sudden HR contacts you to provide you with the ever-so-lovely and enticing thick stack of stark, white paper-black ink guide called the Qualified Retirement Savings Plan – a.k.a. the 401(k). If you’re lucky, the stack may have some parts printed in color with pages containing several intense looking graphs. But what even is a 401(k) plan?
As defined by LearnVest.com:
“A 401(k) plan is a retirement account that you can only access through an employer. You contribute a portion of your salary to the plan, and if you choose to put that contribution in a traditional 401(k), it isn’t taxed until you withdraw the money, allowing your investments to grow over time without being taxed…And, as an added bonus, many employers will match some of your contributions.”
There are two different available choices for 401(k) plans: a Traditional 401(k) and a Roth 401(k). Through a Traditional 401(k) you will be taxed once you withdraw the money at retirement (think about which tax bracket you may be in at retirement, and that is how much you will be taxed on the money invested in your Plan). A Roth 401(k) means that right at this time you pay taxes on your contributions. But, all the money that you earn through your investments will not be taxed whatsoever once you withdraw the money in your retirement (as usual, each choice has it’s pluses and minuses. I have elected to have a Roth 401(k) – but that doesn’t necessarily mean it is the right choice. I just prefer to be taxed now, rather than later).
How this Plan now comes into action is that each time you get paid, a certain amount of money is deducted from your paycheck to be invested into your retirement portfolio (think the intense pie charts pictured in your Plan packet). The percentage that is contributed to your Plan is chosen by you and can range from 1% to 100% of your pay. My suggestion is start at one percentage for a year (i.e. 3%) and then increase the percentage as time goes on. There are many schools of thought as to how much you should be setting aside right now for retirement. The way I think about is the dollars you invest now will definitely have more power in years to come so do what you can. (Please note: if your employer automatically enrolled you into their 401(k) plan, they may have default contributions & investments. If you would like to change these default options and allocations, you most certainly can). A major plus to a 401(k) is: FREE MONEY (yes, you heard that right). Employers typically offer a matching contribution to the dollars you invest in your retirement ranging from 50 cents to dollar for dollar match (for up to a certain percentage of your salary). That is a bonus you may be bonkers to miss out on.
There are several types of investments, but the 3 major ones you mainly hear about through this retirement plan are: Stocks, Bonds and Cash Equivalents.
According to Investopedia.com, here are the breakdown of these 3 major investments:
‘Stocks – a share in the ownership of a company. Stock represents a claim on the company’s assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater.
Bonds – a debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.
Cash Equivalents – an item on the balance sheet that reports the value of a company’s assets that are cash or can be converted into cash immediately.’
For your Plan, you will typically be investing in mutual funds. Think of mutual funds as a portfolio where many people (like you) invest their money together into the 3 mentioned investment types defined above. This portfolio is then managed professionally in order to reach the goals of what you would like to acquire wealth wise in retirement. (Need a visual breakdown? Watch this video here via Investopedia.com).
You may be thinking, ‘Why do I need to start a 401(k) now? I’m still young, I’ve got time!’ Why yes…I’m loving that free & youthful mentality. Trust me, I embody that everyday as well. Even though our minds & bodies wish to continue being young, that does not mean we neglect being forward thinking about the future. Because unfortunately, the market can be incredibly temperamental & will experience glorified highs & awful lows throughout the years until our retirement. This mean that your investment dollars could fluctuate, and throughout your investing you may see lost dollars. The most important lesson to know is that time really IS on your side if you get a hold of it now and will eliminate the risk of the temperamental times the market will have. The market will correct itself over time, so just ride it out (like Johnny Tsunami).
The later you start saving for retirement, the less time you have to let that money flourish & grow. Think of it this way, the all too classic tale – you’ve got that major final to study for in a class you hope to come out on top in. You spend weeks gradually studying (investing & allocating money) & working together with study groups (the other investors through mutual funds) in order to ace that exam (hello, glorious retirement)! With all that preparation, dedication and hard work you’ve absolutely earned that final grade of an A. Now, if you left it up to cramming at the last minute (less dollars to invest), you may suffer sleep deprivation and sickness from these cramming conditions (lost dollars in volatile market with no time to make it up), that you may not get the results you were hoping for – a not so great grade (or slim retirement finds). Granted, this is a hypothetical situation. We all know we have experienced that time where we completely procrastinated and by some stroke of luck we still received the grade we wanted – and I do not mean by cheating! Now which of the two would you prefer?
So hold up! Not so fast – before you think of putting that bad boy packet aside to read later, I am here to strongly suggest (urge) you to enroll in your employers’ 401(k) plan. In most cases, it only requires filling out a form in paper or online in less than 15 minutes of your time! Even better yet, several employers across the U.S. have automatic enrollment to their 401(k) set up for their employees. Where the effort required is actually to opt out from the plan (yikes). Yes, the process may seem overwhelmingly filled with terminology & jargon that makes your head spin, but to put it in one phrase as to why you should enroll in that 401(k) plan, this is it:
You are given the chance to invest in your future self to accomplish anything & everything you would like to do in your retirement.
It is crazy to think that 401(k) plans were only introduced in the 1980’s and that some older generation employees you work with may have not even had the option to enroll in a 401(k). Yes, there is Social Security to acquire in the future, but why not provide a way to enhance your retirement experience with additional income that progressively grows throughout the years you invest to the plan? The way I think of a 401(k) is like this – it’s like you’re watching a sporting event, dance performance, or concert. The whole production is amazing, but it would not be that incredible without ALL of the people and assets working in the background to make it come to life. So that’s just it, your 401(k) is working like a madhouse in the background of your crazy & awesome life to lead up to that glorious finale (your retirement)! If you envision a retirement of travel, relaxation, giving back, visiting with family, purchasing property, or whatever it may be…start that 401(k) today.
Okay, so now you’ve got your 401(k) rolling. Luckily enough too with the advancement of online websites and smartphone apps, you’re able to login regularly to check on the status of your portfolio. Here is another not so fun catch I need to mention about a 401(k). As your deposits start to grow, attempt to not be enticed by the chunk of money that will continue to accumulate into a large lump sum. As millennials and recent college graduates, there is an intense struggle here. Often, throughout our undergraduate years we may have been used to seeing our bank account(s) at levels of double or negative number digits (ouch – I withdrew my account?! Textbooks, living costs, celebrations, trips to home, eating out, drinks etc. could all have attributed to those alarming numbers as a student). Not to mention, a vast amount of us will leave school with staggering amounts of student loan debt. Reframing your mindset to not be tempted by large sums of money in your account is rough. By far, that was one of the hardest disciplines to create after starting a well-paid job straight out of college. The psychological factor of always seeing my bank account at a low dollar amount through college kept tempting me to keep spending to low amounts after I graduated (even though I made more money – that means I spent ridiculous amounts more). Useless and/or frequent purchases would continue to happen left and right because my main mind state was ‘Oh this purchase is justified, I will just get paid again in 2 weeks.’ This is a dangerous trap to lead yourself into because life happens & you may find yourself without the sufficient funds to dodge those curve balls.
Leading away from that tangent, let’s get back to the point of this entry – the 401(k)* If you choose to withdraw funds from your 401(k) prior to your retirement there are heavy penalties associated that you will have to pay. All that money you were working for that was set aside will deplete incredibly fast. I would say muster up as much willpower to not be tempted to withdraw these funds. Remember: these are dollars that will enhance your future of retirement! The money will still be there for you in the future, even though it is not physically with you at the present moment. What if you switch jobs? That is perfectly okay! There are simplified ways to rollover your 401(k) from one employers’ qualified retirement plan to the next with ease. Contact your HR department and/or Plan provider.
So there you have it, a summation of that entirely huge Qualified Retirement Savings Plan packet/book that was given to you. Think of this packet as a gift…one that may not be so shiny & wrapped up now, but one that will definitely become that way when you choose to retire in the various forms of whatever you envision it to be.
There are still many grounds to be covered on a 401(k), but by providing a broken down introduction I hope the motivation to get a jump start on your retirement has been called to action.
Until next time Generation YRA viewers, you are becoming more investing savvy & you may not even realize it!
All my best,
*Your employer may offer a different qualified retirement plan. Or if you are self employed I suggest setting up an IRA – Individual Retirement Account. These are plans I will not be covering in this blog entry but can at a future date.