You’ve reached a stage in your life when it’s time to have the talk. We don’t mean the “birds and bees” or the “what is our relationship?” talk. We mean retirement. You might only be in your 20s, but that doesn’t mean it’s too early to start thinking about what retirement will look like. You’ve heard the term 401(k), and maybe you even know it has something to do with retirement. Perhaps you’ve seen the term on commercials filled with happy looking old people, free to do whatever they want because they have money stored away. But what is a 401(k), really? Do you need one? If so, how soon should you start putting money in? How do you put money in at all? Despite the importance of a 401(k), chances are that no one is going to sit you down and explain one to you. Don’t worry, we’ve got you covered. Here are some important things you should know about retirement so you can start planning for your best future with confidence.
Break It Down For Me
In its simplest form, a 401(k) is a pension plan where your employer sets aside part of your income and lets it accumulate. We understand that as a young employee new to the real-job world, it might seem scary to have any of your income skimmed from the top. But, because the income that goes into a 401(k) is pulled aside before you ever gain access to it, you don’t miss it.
At this point, you might be wondering how a 401(k) differs from your standard savings account. One of the biggest benefits is that unlike your savings account, the money that goes in is not taxed (at least until you actually do access it, which is probably dozens of years from now). So, you’re effectively able to save more because taxes aren’t taken out. Also, to put it simply, interest rates are higher with a 401(k) than with a standard savings account. This means that even if you only put in a little bit, it will accumulate faster than if it were just sitting in your bank account.
One more difference: a 401(k) can function as a simple savings account, or it can be an investment portfolio. Typically, if you choose to create an investment portfolio, you will be responsible for deciding upon investments.
Employer matching. Not every employer offers this, but if they do, they’re essentially offering you free money to invest in your retirement. Many employers will offer to match your contributions up to 5 or 6% of your income. Some (but not all) employers that offer contribution matching will ‘vest’ the money, meaning if you leave their employment within 5 years, they will take back the money they matched -- but your own contributions will still be in the fund.
Even if you don’t plan on being at a job for long, it’s still a good idea to pay into a 401(k). You can roll your money over with each new place you go, so it’s not as if your fund disappears when you switch jobs. Otherwise, you can have multiple small 401(k) accounts -- from each job you’ve had, and that’s okay too. There’s also the possibility that your employer won’t vest their contributions when you switch jobs, which equates to more (free) money in your account.
An important note: in most cases, you cannot withdraw from a 401(k) until you reach 60 years of age. If you withdraw money sooner, there will probably be a 10% fee. While that might seem unimaginably far from the present, if you don’t start preparing now, you’ll be behind when the time comes later.
How Do I invest?
Talk to your employer before you sign a contract. See if he or she offers a 401(k) plan, or if they offer matching. If you have a full time job in a large company, odds are, they probably do.
However, if your employer does not help you to set up a 401(k) fund, don’t despair! There are smaller ways you can begin to save on your own. Some of the simplest forms of retirement saving can actually be through apps on your smartphone. Acorns is an app that rounds up your spare change and places it in a basic investment portfolio (with preset options that don’t require much choice or research on your part). Say you spend $4.26 on coffee; Acorns will round your purchase up to $5 and put the other 74 cents in your fund. It will continue to do this on all of your purchases, only subtracting a fee of $1 a month for operations. Other apps worth looking into are Betterment, Wealthfront, and Wealthsimple. With just a little bit of research, you can find what’s right for you.
It might seem scary or even unnecessary to begin looking at retirement before you even feel situated in your first job, but we promise, it’s not. Having the knowledge of what a 401(k) is and how to build your own will help to set you apart from others and prepare you for whatever comes your way in the future.