Hi I’m Ariel Anderson, Certified Financial Planner™ professional. Today I’d like to talk with you about saving for retirement by reviewing one of the most common savings vehicles: the 401(k).
A 401(k) is an employer-sponsored retirement savings account. When you save in a 401(k), you’re deferring a portion of your annual income. You’re basically saying - “pay me later” vs. “pay me now” with a percentage of your salary. You do this with the hope that any amount you “defer” for retirement will be given the opportunity to grow and ultimately be worth significantly more in the future than it is today. In traditional 401(k)s, employees avoid taxation on the amount they contribute to the plan. The IRS, of course, will never give you a freebie, so they’ll tax whatever you take out of the account come retirement.
The name 401(k) comes from the IRS tax code on which the program is based. If you work for a school or non-profit, you may have something called a 403b instead. They’re essentially the same thing.
The reality is individuals are under increased pressure to self-fund their retirement. The availability of pension plans has significantly declined, and there is a lot of uncertainty around the future of social security. While it can seem a little daunting, there is one thing in your favor if you start early: time. The ability to save and invest your retirement contributions over the course of decades can grow their worth exponentially. Starting late might force you to play catch up throughout your career.
If you’re not saving already, look into your employer benefits with HR to understand how best to take advantage of them. Many employers incentivize your savings by matching every dollar you contribute up to a certain amount. This is like your employer putting 5 bucks on the table and saying - “here’s 5 dollars - you can have it, but you have to put 5 dollars on the table too.” It’s essentially free money, and it’s yours as long as you meet the requirements of the plan. A good place to start is to contribute at least enough to get this full match.
Ultimately, saving for retirement is not a race to achieve a particular number. That’s why we recommend trying to save 15 to 20 percent of your salary on a regular basis until the maximum allowable contribution is reached (in 2017, you personally can contribute up to 18,000 dollars per year, and those older than 50 can save an extra 6 thousand). Start where you can—ideally with enough to get that match—and increase by 1 to 2 percent whenever you get a raise.
Any money you contribute personally will always be yours. You can leave it where it is or transfer it to another tax-advantaged retirement account, like your new employer’s 401(k) or an Individual Retirement Account (I-R-A for short). These transfers are called “rollovers” and they do not trigger any tax or penalties if done correctly. Your HR department should be able to help you navigate these transactions.
Be mindful that if you take a withdrawal from a traditional 401(k) that you will owe taxes on the amount you withdraw, and if you’re under 59 and a half, you’ll get hit with penalties too. A withdrawal is different from the rollovers I mentioned a minute ago - think: cashing a check with funds taken from your retirement account, or moving money from your tax-deferred retirement account to your regular checking account. There are some exceptions, but generally this money is meant to supplement your lifestyle in retirement, and using it early will cost you.
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