401k Savings : An Introduction Part 2
A Brief Introduction to the 401k
In part 1 of the 401k introduction we went over what a 401k retirement savings is and why you should consider making it a part of your financial tool box. Hopefully by the end of that post all of you that are not already participating in a 401k are considering doing so.
A 401k comes with a set of rules and regulations that must be followed
How much can I save
The amount that one can save in their 401k is dependent on the federal limits set for that year. Each year the federal government may or may not change the amount of money you can save in a 401k plan. For the 2017 tax year one can contribute as much as $18,000 with an additional $6,000 catch-up contribution allowed for participants 50 and older. Keep in mind a couple of two can each contribute $18,000 meaning a household of two working adults under age 50 can save as much as $36,000 a year in their 401k retirement account and that is not even counting any match provided by an employer!
Where exactly does the money go when placed in a 401k
Money deposited into a 401k retirement account is held by a brokerage company that in turn invests that money. Typically one can choose how their money is invested with options ranging from low to high risk investments. Sometimes you can pick individual stocks and companies to invest in but this rarely the case. Most 401k brokerage funds give you options that are bundles of investments all under one group. For instance, a target fund refers to a group of investments that are stratified based on risk and the year you plan to retire. The further your retirement is the more risky the investments in that group. "Risk" refers to an investments ability to lose or make you money. The more "risky" an investment the higher the chances it may lose money, however the monetary gains from that risky investment are also considered better than a less risky one. Less "risky" investments are not estimated to make you as much money but also stand less chance of losing money. You do not need to be a stock trading professional to do this. Investments are grouped to make the process easy for anyone.
How much should i save
The absolute least you should save in your 401k is the amount your employer is willing to match. For instance, if your employer states they will match up to 5% of your contribution - you should save at least 5% of your pay. If you save any less then what your employer is matching you are giving up free money! The most you should save is as much as you can afford. The money building power of the 401k is underappreciated. The more money put into a 401k the larger the potential to grow. The average rate of return on a 401k account is between 5-10% a year. That means for every $100,000 in your 401k a return of $5,000-$10,000 a year.
What if i leave my job
Your 401k is yours to keep! Any money that you have deposited into the account from your pay is always yours and can follow you no matter where you go. However, any money your employer gives you in the form of a match may require several years before officially becoming yours. This is known as a "vesting period" and basically gives you an incentive to stay working for the same company. Each 401k plan has its own vesting terms and should be reviewed. Once you have reached the vesting period that group of money is yours to keep as well!
I am too young to save
This is a myth that needs to be extinguished as soon as possible. The strongest factor to the success of a 401k is not the amount of money you have in, but how long you have had money in it! The longer your money has time to grow the bigger you can expect the return to be. Starting as soon as possible is imperative to the success of your 401k.
When can I enjoy all of that money
Any one above the age of 59 can collect money from their 401k without owing a penalty. Money withdrawn will then be subject to income tax as this was never paid all those years ago. You do not have to start taking money from your 401k. You can wait up to 70-1/2 years old before you are required to take money out. The longer you wait the better!
What if I need my money sooner
A 401k savings plan also has the benefit as acting as somewhat of an emergency fund. You are able to take a loan against your own 401k. You can borrow money and pay it back to yourself! Although, this is not recommended to do as it can reduce the amount of money you make and save for retirement it is an option. A common reason persons borrow from their 401k is to purchase a home. If you need your money sooner and do not want to pay it back you can always take it out but it will be subject to a penalty fee for withdrawing your funds early.