Are you one of the millions of workers whose company does not offer a pension for your retirement? If so, then you will most likely rely on the government’s answer to companies taking away the traditional pension, and that is the employer-sponsored 401(k). This is an extremely important aspect of most Gen X, Millennial and Gen Z’s retirement plans. So, you must make yourself aware of what a 401(k) is and how they work. And if you have any questions before or after reading this seek out the guidance of a Registered Financial Consultant.
Brief History
As I alluded to earlier, a 401(k) is an employer-sponsored retirement plan that is named after the Internal Revenue Code where it is located in legislation that was passed in the 1980s to complement traditional pensions. However, as companies realized that they could set these plans up in such a manner that they would eventually replace the company-sponsored pension plans and now most people fund their retirement through these 401(k) plans.
Initially, the plans were established to be funded by the employee with pre-tax dollars in the company’s plan. Then the employee would have the freedom to chose how their funds would be invested within the plan with the investments that plan administrators made available. But not all plans are created equally, then or now, and in many instances your employer does not have the best investments available in their plans due to being sold what is good for the plan administrators and not the employees. On the bright side this situation is beginning to change as employees are fighting back against these poorly administered plans and demanding more accountability from employers seeking fiduciary protection within their 401(k) plans. And more and more employers are listening to their employees and are seeking out the most efficient plans to offer to their employees.
But a recent survey found out the about 40% of Americans can answer basic questions about their 401(k) plans. This means 60% of Americans are investing in the blind and leaving their retirement in the hands of people who may or may not have their best interest at heart. Make sure you understand the basics of how your 401(k) plan works and what you are paying in fees to own your investments.
Mistakes to Avoid
Do not wait to start investing in your 401(k). This is extremely vital to success later and having a well-funded retirement. As soon as you begin to earn a regular paycheck and are working at a company that offers a retirement plan or some sort, take full advantage of it as soon as you begin working. And if you are lucky enough to work for a company that offers a company match on a portion of your contributions, always contribute to maximizing the company match. Otherwise you are leaving free money and an instant return on your investment on the table. And then once you have established your contributions to your 401(k) let the power of compounding interest take over and watch the funds grow, and then in a few decades you will see the incredible power of compounding interest as your account will grow exponentially.
I know that when you are young and just starting in the workforce you have more than your fair share of things that are pulling your salary in many directions. Be that paying off student loans, paying for rent or saving for a house, planning for marriage, or the children you plan to have after you are married are important events and valid expenses in your life. But can you afford to not also plan for retirement? Not everyone’s situation is the same, so what you determine is vital, and must-haves may not be the same for someone else. But whether your goal is current liquidity by paying off student loans or more long-term like saving for a house, you should most likely at least be saving a small amount towards your retirement. Even small amounts compounded over several decades can make a big difference in your retirement. Yes, liquidity is a good goal and being debt-free is or should be the goal of everyone, but you must pay yourself first when making your financial plan.
There are many finance guru’s who preach that being totally debt free is the key to happiness and success. I do not disagree that you should manage your debts, and planning for your 401(k) is just as important as paying off debts. The key exceptions would be to delay paying into your 401(k) if you have high interest credit card or consumer debts. Here I would recommend contributing up to your company’s match then attack your consumer debt. But I would not delay 401(k) contributions for lower interest debts like mortgages or student loans.
How Much to Contribute?
A lot of people ask me and others how much hey should contribute to their 401(k) accounts. That is a question that is not an easy one to answer, mainly due to some of the reasons discussed above. This is where working with a Registered Financial Consultant can pay off. A contribution percentage may be good for one person but way out of line for another. But again, start as early as you can and contribute at least up to the company match.
Ideally, you would want to save between 10% and 15% of your salary in your mid 30’s. But when you are younger and have more expenses pulling at you, this may not be a realistic figure, but 5% is more manageable. But once you have gotten a working budget and financial plan in place you will be able to save with some ease, and when you get that hard-earned raise put a portion of it into increasing your 401(k) contributions. That way you live at the same level you did before but are now saving more towards retirement.
401(k)’s do not have to be these mysterious retirement tools if you take a little time to understand how they work. By doing so, you will be more informed and better equipped to make decisions concerning your retirement 401(k). But if you need assistance reach out to a fee-only Registered Financial Consultant.
If you have any questions or need any assistance, please feel free to reach out to me directly. To join our email newsletter, please fill out the form below.
