Many companies offer 401(k) plans, but not all employees take advantage. Editors at Yahoo Finance did some digging to find out 1/3 of eligible millennials aren’t signing up. In their latest two-minute-money report they lay out reasons for contributing to a 401(k) and how they work. Check out the full article at:
Also here's a quick checklist of what you need to know:
How do 401(k)’s work
- A fraction of each paycheck gets invested in your retirement fund—before taxes are deducted.
- In addition to tax savings, your company might match a portion of your annual contribution. Say you invest 3% of your income—some employers will match you dollar-for dollar. Say you make $55,000 a year. At 3%, what comes out of your yearly paycheck is $1,650, but what goes into your 401k is $3,300. A generous company will match a higher percentage. An extremely generous, lovable company will match your contributions up to 6% of gross income.
What should you invest in?
- 401(K)s give you options. A good reason to enroll now is you can confidently invest more of your savings in index fund based mutual funds and target date funds —with potentially greater payouts.
- But you can devote most of your savings to more stable bonds as you get closer to retirement.
Is there a catch?
- Yes, severe tax penalties if you cash out before 65. So don’t cash out early. Patience pays off play the long game.
- There’s an upside if you do: a break on your tax returns. A quarter of your annual contributions—roughly—can be written off each year tax-free interest for decades. While your 401(k) matures, earnings compound tax-free.
Why is a 401(k) better than your typical savings account?
- Even though you[‘re taxed after withdrawal, they’re still the better option.
- Say you have an average salary of $100,000 over a 40-year career. If you set aside 10% each year, and your employer matched 5% the contributions would grow tax free, every year. An average 5% rate of return means that your earnings from each year would be added to the balance that earns 5% next year. In 40 years, you’d grow an extra $900,000! And retire with a balance of $1.5 million!
- If you had put 10% into a savings account instead, you’d have invested $300,000 and paid taxes along the way.
Even if your employment situation changes/you switch jobs, don't cash out!
- You can leave your money in your previous employer's plan
- Roll over your 401(k) to your new employers's plan
- Move it into an IRA (Individual Retirement Account.
Check up on your 401(k) but not obsessively. Market is constantly fluctuating. This is the looooong game.
- You always have the option to rebalance (changing what % you want in equities vs. bonds) but get professional advice, don't act rashly just because of one down day/week/month