What College Grads Need to Know About 401(k)s
Just like that, 4 years of college…gone! Vanished! You have your whole life ahead of you and are about to start a new chapter in the working world. Even though you just graduated and you feel like retirement is at least 100 years away, it’s really going to go by in the blink of an eye and the sooner you can learn about and start contributing to a 401(k), the more financial freedom you will have when the checks stop rolling in.
401(k) plans are named after the section of tax code where they’re described. They’re a type of salary-deferral plan utilized by private-sector employers, which means you designate a percentage of your salary to contribute up to $18,500 per year.
How does a small percentage of your salary each year amass to enough money to live off for 30 to 40 years, you ask? Well, your contributions aren’t just going to be held away in some secret savings account somewhere. They’re actually going to be invested and compounded over the life of your career. You’ll work with your HR and Payroll departments to set up the account, but it will be up to you to pick your investments. Seek out the advice of a trusted financial advisor to help you with this process and ensure that you’ve selected the proper asset allocation to reach your goals.
What You Need to Know About Contributing
Take The Full Match—It’s Free Money
Employers will often “match” your contribution up to a certain percentage. A common mistake people make is not contributing enough to get the full match. Say you make $50,000 per year and your employer’s full match is 4%. If you also contribute 4%, you’ll have set aside $2,000 and gotten an additional $2,000 in free money from your employer. In that scenario, you’re doubling the amount you have set aside for retirement by doing absolutely nothing. Contributing enough to get the full match is just one of those things you need to do or people will call you crazy.
You Can Save on Your Taxes
Your contributions are tax-deferred, which means you don’t pay taxes on your contributions. Instead, you pay taxes when you withdraw the money at retirement. Every dollar that you contribute to retirement is deducted from your taxable income, which means you will owe less in taxes than if you didn’t contribute.
The Earlier, The Better
There are two key components in investing: compound interest and time. The earlier you start, the more time your money has to compound and grow. Check out our Two Savers example to see just how beneficial it can be to start investing early. Even though retirement might seem like a lifetime away when you’re 22 and just starting your first job, it’s important to think about the lifestyle you want to maintain in the future when you’re no longer earning money and get a plan in place to secure it.