Early in a career it’s easy to forget about retirement. It seems distant, but when it comes to saving and learning about sound money management strategies like 401(k)s, the earlier you start, the better.
A 401(k) is an employer-sponsored retirement savings plan. These plans were started in the 1980s and are named for the section in the tax code under which they are governed.
A 401(k) allows employees to invest a percentage of their pay before taxes. Taxes are not paid until money is withdrawn. 401(k)s also let employees control how their money is invested with most plans offering a spread of mutual funds composed of stocks, money market investments and bonds.
There are two types of plans, the traditional 401(k) and the Roth 401(k). The main difference of these lies in their tax implications and their schedule for accessing funds. With a Roth 401(k), income taxes for contributions are paid up front and contributions do not reduce taxable income, however, the money in the Roth grows tax free. When money is withdrawn from a Roth, it is generally not taxed.*
The IRS limits traditional 401(k) contributions to $18,000 for 2015.
401(k)s can help with retirement saving but they also have some restrictions. There are penalties for pulling funds out before retirement age and rules on when money may be withdrawn. It’s important to know employer’s unique restrictions. Some employers will match your contribution to your 401(k) plan up to a certain percentage. The most popular match is 3 percent of an employee’s salary, according to the Profit Sharing/401k Council of America.
Employers usually hire third party administrators to handle 401(k) accounts, like U.S. Bank. The administrator provides updates on plan performance, assists with requests, and manages paperwork.
Remember, putting the minimum percentage into your plan and forgetting about it until retirement is not the best route. Greater Phoenix Chamber of Commerce member U.S. Bank shared the following 401(k) tips for young professionals.
- Max out your 401(k) because you will never miss the money if it is out of your paycheck. In addition, many employers match your contribution up to a certain level, which is like getting a raise. Young professionals have time on their side when it comes to wealth accumulation. The more you put aside at an early age, the better off you will be financially when you retire.
- Don’t set the asset allocation in your 401(k) and forget it. You need to make periodic asset allocation adjustments along the way because the financial world changes as well as your needs. It makes sense to look at your 401(k) about twice a year to make sure that the investments are current.
- Take advantage of any educational resources your employer has to offer with regard to 401(k)s and retirement planning. The more you understand the underlying investments in your portfolio and what is driving performance, the better decisions you will make.
*According to Fidelity, a Roth account withdrawal is tax free and penalty free if the Roth is five years old and one of the following conditions is met: you reach age 59.5, are disabled, make a qualified first-time home purchase, or die.
-Written by Carolina Lopez, digital marketing administrator for the Greater Phoenix Chamber of Commerce. This article is part of the Chamber’s monthly VYP email newsletter. Check out VYP’s Facebook page to stay updated on VYP events.