A 401k is a retirement plan that is sponsored by your employer. It allows you to invest a piece of your paycheck and control how your retirement funds are invested. Most plans offer a spread of stocks, bonds, and money market investments.
How to Use Taxes to your Advantage
You’ve got 2 options when it comes to your 401k. The traditional 401k allows you to contribute income and only pay taxes on the funds when you withdraw them during retirement. The second type known as a Roth allows you to pay the taxes upfront so when you make withdrawals during retirement it will be tax-free. Roth is the ideal account to have while you’re younger because the taxes you pay now will be low in comparison to the tax you’ll pay when you’re older and more likely to make more money.
Traditional retirement is many years away but it hasn’t stopped me from planning for it. It’s ideal to invest as much money as possible toward retirement if you don’t have debt that needs to be paid or have your money tied up in other things. Many companies match a certain percentage of your savings, you’re throwing away free money if you don’t at least put up your companies match amount. The max amount you’re able to defer into your 401k rises each year.
How Your Funds Are Managed
Most employers use an administrator like Fidelity NetBenefits to oversee your investments. You can stay updated about your plan’s performance and shift money yourself through an online app or webpage. Early in your career, it’s important to invest in the funds that are moving the most aggressively upward and to reevaluate your portfolio every 3 months. The reason for this is the most aggressive markets are also the riskiest, but the gains you make from being aggressive will compound in the years to come.
Taking Out Money Early
Lastly, some companies let you take up to 50% of your 401k balance as a loan which usually must be repaid within 5 years. One of the biggest reasons why you shouldn’t take out a loan against your 401k is double taxation. This is because you’re paying back a loan with money that has already been taxed just so it can be taxed again when you draw from your traditional 401k. Taking a loan out against your 401k may not be the best idea unless it’s an emergency. Most investors suggest that your money will double every eight years on average but without the money in your account to grow over time you’re missing out on a huge opportunity.
Even worse, if you end up in a situation where you’re unable to repay the loan it is treated as an early withdrawal and you’ll be hit with a 10% early-withdrawal penalty if you’re under the age of 59 and a half.
Only as a last resort and after you’ve exhausted every other alternative most employers offer hardship withdrawals if employees meet certain guidelines. In some cases, you can pull money out without paying the 10% percent penalty for early withdrawal.
Question: Have you started planning for retirement even though it’s almost 40 years away? Why or why not?