Let's say you've started your first job. Or, maybe, you've simply started to think about saving for retirement. Your employer offers a 401(k), but you don't know where to get started (or even what that is). Here's everything you need to know.
What Is a 401(k)?
To put it in really general terms, a 401(k) is a retirement savings account offered through your employer. (If you're self-employed, you can open a Solo 401k, but that's a whole separate topic).
You set aside a certain amount of money each month from your paycheck, and use it to invest money through this account. You have the option of investing in a variety of assets (i.e. stocks, bonds, mutual funds). Over time, your money grows. Ideally, when you retire, you'll have a big stack of money that's been growing for years.
The money you earn from your 401(k) investments isn't taxed until you withdraw it—ideally, after you've retired.
Why Do I Want One?
Saving for retirement is boring, but important, and you should do it as soon as you can. Saving even $50 a month can work for you.
With a 401(k), your company might offer to match a percentage of some of your 401(k) contributions. This is basically free money. Also, since the money you invest is 'pre-tax,' you could reduce your annual tax bill. CNN Money explains:
Another benefit to having a 401(k)-retirement plan is having taxes deferred until you withdraw the money at retirement. So, since the 401(k) actually reduces your tax rate, you won't be paying taxes on the money until you withdraw it. Since many people tend to be in a lower tax bracket when they retire, the 401(k) actually has you paying a smaller tax rate on your savings when you take it out of the account.
Of course, you'll eventually have to pay taxes on this money when you retire.
How Do I Pick My Investments?
When you open your 401(k), you'll have to pick your investments. Your employer usually works with an investment broker to come up with a list of options. This means you're stuck with the list they offer, and sometimes, the list isn't great.
Either way, you'll have to pick a fund from this list that's based on a risk level you feel comfortable with. Investor Place runs down the five major types of funds you'll likely have to pick from:
Stock Funds: As the name suggests, this type of fund covers a variety of stocks that you can invest a percentage of your account in. According to Investor Place, Target-Date Funds: These funds are pretty simple and basic. You pick your target date for retirement, then pick the matching fund. Because they're so simple, there's not much maintenance, as the fund adjusts your asset allocation over time. The fees of target-date funds might be higher.
Blended-Fund Investments: These funds have a set ratio of stocks and bonds. You can pick one that's appropriate for your situation. This means you'll have to consider your tolerance for risk and how many years you have until retirement.
Bonds/Managed Income: These are funds are meant to safeguard your money, but your money won't grow much with these funds.
Money Market Funds: Investor Place calls the money market fund a 'glorified CD.' There's zero growth here, and, in fact, these funds barely keep up with inflation rates. They recommend avoiding money market funds if you want your money to grow.
tags: 401k, starting a 401k
NFPR-2019-80 ACR#324833 09/19