401K Starts Today
401K Starts Today
Like many a milestone, a first “real job” can be overwhelming. #Adulting does have its perks, one of the more intricate facets in financial planning, or “putting away money for later,” “reserving” as Mr. Ariel Serber, of Lions Financial, so diplomatically states
I took Principles of Finance, I read the WSJ (okay the front page), but boy was I in for an eye-opener. Financial planning can seem so complicated, yet with the right guidance and some personal savvy, after all, you have to know something to understand what to inquire about. This is your 2019 jump right it into the vast spectrum of “reserving money for later.”
According to the WSJ, a 401K is
“A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.” Nice.
Besides for the employee and employer, which outside parties are involved?
The employee company serves as the "plan sponsor" for the 401(k), but it doesn't have anything to do with investing the money. Instead, the plan sponsor hires another company to administer the plan and its investments. The plan administrator may be a mutual fund company (such as Fidelity, Vanguard or T. Rowe Price), a brokerage firm (such as Schwab or Merrill Lynch) or even an insurance company (such as Prudential or MetLife).
What about Pensions? I've heard of those...
Initially, 401(k) plans, arose during the 1980s as a supplement to pensions. Most employers used to offer pension funds. , and they paid out a steady income throughout retirement. But as the cost of running pensions escalated, employers started replacing them with 401(k)s.
With a 401(k), you control how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be target-date funds, a combination of stocks and bonds that gradually become more conservative as you retire.
So far 401(k)’s sound great, but like all good things in life “ain't no such thing as a free lunch,” does 401k’s have any restrictions?
In most cases, you can’t tap into your employer’s contributions immediately. First, you must be vested. Vesting is the amount of time you must work for your company before gaining access to its payments to your 401(k). E.g., a company saying you can’t have access to 401(K) “benefits” until you've served, (I meant worked :) …) at said company for three years. It’s an insurance against employees leaving early. On top of that, there are complicated rules about when you can withdraw your money and costly penalties for pulling funds out before retirement age.
Is there a formula, like how much money to allocate to (necessities, e.g. Uber, phone plans, dinner :), savings?
The answer is as much as possible. Being mindful that you’ll need to have enough money to live, eat and pay down any debt you have. At the very least, invest enough to get the full matching amount that your company pays to match your contributions. You don’t want to leave free cash on the table. Nearly every plan offers matching funds—the most popular being 3% of your salary.
So how would a 3% match work?
If you put in 3% of your $50,000 salary, or $1,500, your company puts another $1,500 in the pot. You can add more than that $1,500 yourself, but the company won’t match beyond 3%. The rules for matching funds vary, so be sure to check with your employer about qualifying for its contributions.
Are there limits to how much you can put into a 401(k), cause it's basically taking your pre-tax salary and putting it away for later.
The IRS does mandate contribution limits for 401(k) accounts. There are annual limits. The maximum employee deferral for 2018 is $18,500 per person. There is also a maximum Catch-up Contribution of $6,000, which is only available to participants age 50 and over.
There was also a $1,000 increase to the Total Contribution Limit for 2018, which now comes to $55,000. The max deferred compensation includes employee contributions, matching contributions, bonuses, and other deferred compensation. (If you are over age 50, you can also add your catch-up contributions to this number, bringing the max total deferred contribution limit to $61,000 for 2018).
You’ll also want to consider the type of 401(k) you choose. They come in two varieties, the main differences being the tax implications and the schedule for accessing your funds. Chances are your company offers a traditional 401(k). Less common is a Roth 401(k). Here’s the breakdown of each:
401k type
Tax rules
Withdrawal rules
Traditional
· Wages are contributed before taxes from each paycheck, like a deferred salary.
· Taxable income drops by the amount you contribute.
· You pay income taxes on contributions and earnings upon withdrawal.
· No access to your funds before age 59 ½ or if you leave your employer at age 55 or older.
· If you dip in early, expect a 10% penalty — on top of the usual tax bill.
Roth
· Contributions are made with money that’s already been taxed.
· No taxes paid upon withdrawal.
· Better flexibility: free access to your money as long as you’ve held the account for five years.
Most companies allow you to enroll in a 401(k) right away, although some smaller employers might make you wait up to a year. If that’s the case, set up an individual retirement account, and complain with your employer’s HR office. Some companies will automatically register you. You can generally increase or decrease your contributions at any time. Don’t forget to elect a beneficiary or the person who gets your money if you die. (If you’re married, your spouse is automatically the beneficiary.)
Finally, if your company is on shaky ground, don’t fret. Your 401(k) is off-limits. If your company goes under, the plan would most likely be terminated. If that happens, you should roll the money over into a traditional IRA to avoid paying the 10% withdrawal penalty and income taxes.
