Your 401k & How Much To Contribute
Ahh, the 401k – how much to contribute .. an age-old question. You’ve probably noticed a lot of information floating around – what to do, what not to do, how to do it, when to do it .. This article shows you what you need to know.
Though retirement investing is a pretty complex topic – one that you should ideally get personalized, professional help with – I’ll try to give you some “rules of thumb” here..
At Least Take The Free Money
A lot of employers match contributions at some percentage level. Meaning that whatever you put in, they put in on top. Taking advantage of this is an absolute no-brainer. It’s free money. BUT… A lot of times there are “vesting” schedules. Vesting is a process by which the money in your account goes from belonging to your employer, to belonging to you. To make a long story short, if you quit or get fired before a certain amount of time, the money that your employer put in to “match” goes back to them. SO if you’re planning on being there for a while, you’ll get a bunch of free money. 401k, how much to contribute? If you can afford it, at least take advantage of the free money matching.
How Old Are You?
Your age will actually be one of the main determinants in answering the ‘How much should I contribute to my 401k?’ question. If you’re nearing the retirement age of 59 and-a-half and you don’t have enough money saved up, then clearly you should contribute as much as possible. Ironically, if you’re still young, like in your twenties or thirties, and have many years until retirement, you should also contribute a lot. A good rule of thumb is to contribute any money that you don’t actually need. Remember, you won’t be able to take this money out of the account without a lot of hassle and some taxes/penalty, so be sure you won’t need the money any time soon.
Pay Yourself First
One characteristic of successful investors is that they have a habit of regular contribution. Luckily, your plan is probably automated and makes this easy. An awesome rule-of-thumb that I encountered recently is to strive to save at least 15% of your earnings. If you can get into that habit, especially at a young age, then you should be able to retire comfortably. If you look at historical stock market performance, pretty much any 20-year period yields ridiculous profits for consistent, long-term investors. Check out some historical stock market data here
Did You Max Out Your Roth?
Most people can contribute to BOTH a pre-tax 401k AND and after-tax retirement investment account like a Roth IRA. I personally like to max-out my Roth IRA before I max-out and 401k because I like the tax treatment of Roth IRAs better. In a nutshell, after-tax accounts like Roths are funded with AFTER-TAX dollars, meaning you already paid taxes. After you put the money in – you never have to pay taxes on it again – no matter how much cash you earn from investing. In a 401k, you invest with PRE-TAX dollars, meaning that taxes have not yet come out. And they won’t come out – until you’re retired and start withdrawing the money. May sound like a good deal, but likely when you’re older, you’ll have accumulated significant earnings — meaning that the dollar amount you’ll pay in taxes is much higher than if you would have settled with Uncle Sam on the front-end. Long story short, 401k – how much to contribute – if you haven’t maxed-out your Roth yet, you may want to save some of your investment dollars for that.
Learn more about Roth IRAs at the following pages:
Roth IRA explained How much can I contribute to a Roth? Roth IRAs vs. Traditional IRAs (gives a good explanation of PRE-tax vs. AFTER-tax in case you’re still confused) Can I roll my 401k into a Roth?
Learn more about 401ks at the following pages:
What’s the difference b/w a 401k and an IRA?
How to roll a 401k into an IRA
What happens if I have to make an early withdrawal from a 401k?
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“What Is an IRA, Anyhow?” The kid looked at me with a blank stare, “What is a IRA, anyway? You’ve been talkin’ about them for like, half an hour, but I got …