shopping for a 401k plan

What to Consider When Getting a 401k Plan

Retirement is an incredibly important part of your financial planning. You absolutely cannot start early enough, but with that being said, it’s never too late! Whether you’ve already begun a savings account or not, you can absolutely begin setting money aside now and reap the benefits later.

If you’re employed and your employer offers a 401(k) retirement plan, it might be perfect for you. 401(k), named for a section of the tax code that governs this type of retirement account, is relatively easy. There are plenty of pros (and very few cons!) to investing this way, so first let’s get educated on what this plan includes.

Breaking Down Your 401k

Pros of a 401k

Your savings is taken directly from your payroll (via your employer). Sometimes employers offer a 401(k) savings plan as soon as you start your new job. If this is the case, it’s most beneficial to jump right in! Yes, your paycheck will be slightly leaner than it would be if you weren’t investing in your future, but your future self will thank you. You’re also in control of how much comes out of your paycheck. You can contribute the maximum amount according to your employer, or less than that. Most people find that contributing the maximum amount straight from a paycheck is not a tough pill to swallow.

As of 2019, you can save up for $19,000 of your income ($25,000 if you’re over 50) for retirement. Now, some of you might be thinking that’s almost what you earn! Of course, you don’t have to contribute that much. But as soon as you can, you absolutely should. Start with what’s comfortable and slowly increase that amount. If you increase 5-10% at a time, you probably won’t even notice.

If you leave your job, your 401(k) rolls over to your next job! That’s right! Even if you stay with a company for 30 years, you can easily move your 401(k) to the next job and continue saving (and earning!). Be sure to communicate with your previous employer and your new employer to ensure everything rolls over properly, but the process isn’t complicated.

Many employers will match your contributions to your 401(k)! This can double your money! When you begin with a company that matches your own contributions, immediately take advantage. Ask them what the cap is on their matching contributions and remember – this is basically free money for your future! Take it!

Cons of 401k

There are penalties and fees associated with taking money out of your 401(k) prior to turning 59 ½. If you find yourself in a pickle and you need the cash the you’ve put into your retirement account, you’re going to be sorely disappointed when you see the dent it makes in your hard-saved money. Removing any amount of money results in a 10% penalty fee as well as income taxes on the amount you remove. That means if you take out $5,000 before you turn 59½, you’ll be paying $1,700 in penalties and taxes (if you’re in an average 24% tax bracket)! That’s more than 30% of your money GONE! Avoid removing money from your 401(k) at all costs!

There are account fees associated with 401(k) plans. It’s important to research the way your plan is set up to ensure you’re paying the least amount of fees possible. On average, these fees can range from .5% all the way to 5% of your overall assets! An average employee starting out at 25 years old will pay almost $140,000 over time until they retire in fees!! These fees include investment fees, administrative fees, and individual fees. The way your employer sets up your 401(k) will determine just how many fees you pay (and many will actually invest in passively-managed retirement accounts to help keep costs low). Some employers pay these fees for their employees, and if your company does that it’s a big win!

There are few options in terms of investing with a 401(k). Other retirement plans, such as an IRA, can diversify money amidst some very interesting choices that are off the beaten path and sometimes even a little big exotic! You won’t find these opportunities with a 401(k). Basic stocks and bonds will make up a majority of your investments. The pro of this is that your retirement accounts won’t be complex, so even if you aren’t well-versed in finance, you’ll have no trouble understanding how your money is being invested. It’s a fairly streamlined process.

This last con is a great reason why it’s important to learn more about what makes up a 401(k). Most people are never actually clear on how a retirement account makes money over time. When you’re looking into a 401(k) plan, it’s important to understand how to allot your money in order to meet your specific goals and where you are in life.

What to look for in a 401k

The money you allocate for retirement can be invested in several different ways. Where you allot that money can be complicated, but with a 401(k), determining how to allocate your money can be far more simple than that of other retirement accounts. Of course, you should have a guide or an advisor available to you through your place of employment, but if you don’t then seek out a professional who can help you make these decisions. The most important thing to look for in your 401(k) is an allotment that meets your goals and needs, which are typically defined by your age.

Investing for Retirement in your 20s and 30s

Generally speaking, the younger you are, the more risk you can typically take with your allotments. If you’re under 40, go ahead and consider investing everything in equities (stocks). Over time, these investments are almost always the best bang for your buck. Yes, you’ll see ups and downs in the market, but stocks shake out as the best investment time and time again. You can also try several well-performing index funds. Now is the time to really go for it because, as you age, your ability to earn will slowly diminish. Taking a big financial hit at 30 isn’t nearly as devastating as taking one at 60, and you’ll likely have time to recover prior to retirement anyway.

Investing for Retirement in your 40s

As you enter your 40/50s, focus slightly less on equities and slightly more on fixed income. A fixed income account is far safer and ensures a bit less risk as you get closer to retirement. This money can’t be lost. This a fixed-interest account and considered very safe and slow growing. Remember, though, that investing too much in a fixed income account too soon will greatly reduce your overall retirement account. Stay the course with your stocks, keeping about 70-80% of your allotments there, as you begin to build a strong foundation for the future.

Investing for Retirement in your 50s and beyond

Growing into your 50s signals a big turn in how you should be allocating your retirement money. It’s now that you might consider reducing your stock investments to 50%, and slowly continue reducing by 5% each year until your entire. The rest should be in a fixed-income account.

Know Thyself

The way you invest in your 401(k) is completely up to you. If you aren’t sure how to invest, or you’re intimidated, it’s a good idea to begin by asking yourself what’s true about you. Are you a risk-taker? Are you in it for the long-term? If the money is accessible, will you spend it? Can you sleep at night knowing your money is being managed by someone else? Take some time to consider what is true for you and invest accordingly. For example, if you’re not going to be able to relax knowing your money is invested in the stock market, try investing far more in a fixed-income account. Maybe in time your feelings will change, but if it’s going to cause undue stress, there’s no reason to start out with riskier investments.

If you feel like it’s too late to start investing in a meaningful way, you might have another option called target-date investing. This investment involves you communicating the date you hope to retire by to a fund manager. This fund manager will invest your money for you in hopes you maximizing the time you have before the day you need to start using those retirement funds. It’s kind of like putting your retirement on autopilot, and it’s a great opportunity for many people.

Can you invest in a 401(k) without an employer?

If your employer doesn’t offer you a 401(k), there are many options. One option is called a Solo 401(k). This might be the most difficult option, as the paperwork involved in opening this type of account is plentiful! It’s great if you have a guide or financial advisor, but even so there are many rules and regulations you must follow in order to be tax compliant. If you’re self-employed, this option does allow for greater contributions each year (comparable to a 401(k) offered by an employer), though, so it’s a great opportunity if you’re willing and able to learn it’s an opportunity.

What might be a better option is a “Simplified Employee Pension Individual Retirement Account,” or SEP-IRA. You must be self-employed or own your own small business for this one. You can contribute a sizable amount of your income to this account (up to 25%!), all of which is tax deductible. If you have employees, you can also offer this to them.

If you aren’t self-employed, a Traditional or ROTH Individual Retirement Account is a great choice. Your contributions with a Traditional IRA are tax deductible, but you pay taxes when you retrieve the money at retirement. The opposite is true with a ROTH IRA. While there’s a contribution cap of $5,500 for both (as of 2019), these are straightforward accounts open to anyone. You can also open one of these accounts if you already have a 401(k).

It’s tempting to spend the money you make, especially after taxes are taken out. After all, you’ve already given up so much! But your future self will be so grateful that you took the time to educate yourself and invest in your retirement. Hopefully you have an employer that is willing to match your annual contributions, but even if you don’t, every little bit counts. If your employer doesn’t offer a retirement account at all, there’s still plenty of opportunities to invest. Find a financial advisor near you and start talking about what’s possible! It’s never too late to start.

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