Understanding that most of us can’t rely on social security or pensions to live off during retirement is pretty scary, but it’s even scarier to know that you are not taking advantage of your 401k employer matching contributions. Let’s change that!
What is a 401k
A 401k is a tax-advantaged, company-sponsored retirement account that allows employees to contribute a portion of their wages. You as an employee can contribute a specific amount or percentage of your salary to this 401k plan which will grow over time and become accessible once you retire (starting at age 59½ ). Some employers will match up to a certain percentage of your contributions, meaning that your company is giving you free money if you are contributing to it (for example, they may match dollar per dollar up to 6% of your salary contribution).
If your company offers a 401k plan you should definitely take advantage of it as you will get a guaranteed return in investment based on how much your employer matches your contributions. Some employers will automatically enroll you in these retirement plans. If you are not enrolled or you are not sure of your enrollment status, then you should talk to your HR department. Let’s dig a bit more into this retirement account which has potential to make you a millionaire by the time you retire!
There are two types of 401k accounts: A traditional 401k and a Roth 401k. Both of these plans are usually offered by employers, but the traditional 401k is typically the most common and this is what we’ll focus on.
With a traditional 401k, any contributions you make are tax-deferred, meaning that you won’t pay taxes until you withdraw the money at retirement time. The great thing about a traditional 401k is that your money will grow tax-deferred; therefore, maximizing your potential gains until you retire. It is important to note that you will eventually pay taxes at the time of withdrawal, and there is a 10% penalty fee if you withdraw before your retirement age.
With a Roth 401k, your initial contribution is taxed; however, you won’t pay any taxes when you withdraw the money at retirement time. This also has the advantage of knowing exactly how much you’ll be able to withdraw at retirement time since you won’t be taxed in the future.
How much can I contribute to my 401k?
For the current year 2020, and 2021 the maximum contribution limit is $19,500. For individuals older than 50 years old, there’s a catch-up contributions of up to $6,500. This allows individuals who missed out on contributing to their 401k in earlier years to contribute more and expedite their contributions for their retirement.
If you can’t contribute up to $19,500 a year, don’t worry. The least you can do is contribute the amount that your employer is matching as this is free money; however, you should contribute more than that to ensure that your money grows significantly by the time you retire.
As I mentioned before, if you don’t invest at least the amount that your employer offers to match then you are missing out! This is the equivalent of walking away from free money on the table.
With these matching contributions, your employer contributes money into your 401k plan as long as you are putting money in it. For instance, they may match your contributions dollar for dollar up to the first 4% of your pay, then they might contribute .30 cents to the dollar for the next 2%. In this case, you want to ensure you’re contributing 6% of your salary. Again my recommendation is to put as much as you can in your 401k. Personally I contribute 12% to mine or close to $16k a year.
If your employer does not match your 401k contribution, don’t worry! You can and should still contribute to your retirement fund.
When can I withdraw my money?
You can only withdraw your funds without penalties when you hit age 59½ and later. Withdrawing your money before the age of 59½ will result in a 10% penalty, on top of your tax bill.
Always, always, always! Remember that your 401k is for retirement purposes. People will often be tempted to withdraw the money before the retirement age which is not a good idea. You will miss out on years and years of compounded interest; therefore, don’t touch your money if you don’t need to!
There are certain hardship situations in which a person can withdraw their money without incurring the 10% penalty; however, I will let you dig into that information on your own as I don’t condone withdrawing the money.
Question#1: What happens to my 401k if I switch employers, or if my employer goes under? Answer#1: You may roll the money over into a traditional/Roth IRA to avoid paying the 10% withdrawal penalty
Question #2: What if my employer does not offer a 401k? Answer #2: You can open a traditional or Roth IRA which is another retirement account. I will write another article on this later.
Question #3: Where does my money go when I contribute to my 401k? Answer #3: Typically your money will go into a mutual fund that will be managed by a fund manager. This means that your money is being invested into various securities such as stocks, bonds, etc. Depending on your age, make sure that you log in at least once a year to your 401k portal and ensure that the risk level is in accordance to your age. For example, if you are 25 years old, your mutual fund should be set to high risk, compared to a person who is 50 years old. If you have any questions talk to your HR representative.
Maxing out your retirement funds such as 401k, Roth IRA, and HSA will allow you to increase your wealth over time and retire without worrying about money. No one wants to be past retirement age and working due to unforeseen events such as health complications, or lack of savings. Additionally, if you love your kids, do them a favor and plan for your future so you won’t become a financial burden once you become old. It is something very important to me and my family and I believe you should do it as well. Thanks for reading!
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