Why you need to know this: If you work for a company that provides 401(k) benefits, you should participate in the plan.
So you have a job at a company. Awesome, you’re earning money! And that company’s benefits include a 401(k). Lucky you! A 401(k) is a company sponsored retirement account, and you should take full advantage of it because you know that the sooner you start socking money away into a retirement account, the more money you’ll have when you’re an old person.
A 401(k) is a way to put pre-tax money into a retirement account, meaning this is money from income which you haven’t paid taxes. This is great because it allows you to take a portion of your paycheck and invest as much of it as possible before taxes are taken out. You’ll pay an income tax when you withdraw this money during retirement.
Getting started is also really easy because all you have to do is ask your company’s HR representative (or whoever is in charge of payroll) to get you enrolled, and set up an automatic payment plan so that the money is automatically deducted from your paychecks and deposited into your 401(k). It’s easy, just say, “I want X dollars from every paycheck deposited into my 401(k),” and boom, you are good to go.
Companies usually give you a packet of information about your 401(k) benefits during some sort of employee orientation. Don’t pay too much attention to it because that literature is usually dense and filled with complicated jargon, which might intimidate you and make you put off investing in your 401(k). Don’t let this happen! Seriously, all you need to do is talk to your HR person for five minutes to get you set up and explain all the important key things. My last HR person was named Mo, and he was great because he set me up and told me the minimum amount I needed to invest every month from my paycheck to get a full match from the company.
Speaking of which, If your company offers you a 401(k) match, make sure you get every cent of it! As an incentive to get you to put money into your 401(k) some companies will offer you a dollar for dollar match up to 3 percent of your salary (that’s typical, some might even give you more). So, for example, if you earn $50,000 per year, your company match for the year will be $1,500, and that money will be put into your account if you contribute at least $1,500 (a mere $125 a month) into your 401(k) for a total investment of $3,000. It’s basically free money! So be sure you’re contributing enough to get a full match.
Oh, what’s that? You want to be an overachiever and invest more than what your company matches? Well, the IRS limits the amount you’re allowed to contribute into your 401(k). For 2012, the most you can contribute is $17,000, which is a lot of money, and if you’re putting that much away — good for you!
So what happens after your money goes into your 401(k)?
The money you contribute to your 401(k) goes into an investment account managed by an investing company like Fidelity, or ShareBuilder, or whatever company your workplace has decided to use. You can then choose from several investment options, for example, “conservative”, “balanced”, “moderate”, and “aggressive”. Don’t stress out about it too much, because your company should be narrowing down the best options for you. If you’re in your twenties or early thirties, people who know things about money (“financial advisors”) usually recommend that you invest as aggressively as possible because you’ll have more time to ride out the ups and downs of the stock market, and then invest more conservatively as you age and get near your retirement so that you don’t lose it all right before you want to stop working.
That’s pretty much it! Here’s a recap for people who like to skim:
• A 401(k) is a employer sponsored retirement account
• You get to invest a portion of your paycheck into your 401(k) before it gets taxed
• Talk to your HR person to get you set up
• Figure out if your company offers a 401(k) match, and invest enough to get a match
• The most you can invest into your 401(k) in 2012 is $17,000. You can invest an additional $5,500 if you’re over 50.
• If you’re young, invest aggressively, because you’ll be able to ride out the ups and down of the stock market. Get more conservative as you age and near your retirement.
What To Avoid (aka, Don’t be dumb!):
• Not getting enrolled in your company’s 401(k) (Seriously, 25 percent of workers who are eligible for 401(k) benefits don’t sign up for it. These people are dumb. Don’t be dumb!)
• Not contributing enough to get a match (Your company is offering you free money, and you’re not taking it. Don’t be dumb!)
• Withdrawing money from your 401(k) before you’re 59 and a half years old because you’ll pay income taxes, plus a 10 percent penalty tax. This money is meant for your retirement, so the penalty is there to discourage you from withdrawing it to buy stuff now. (Don’t be dumb!)