Episode #12 - At a dozen episodes, let's try 401K
Whether you've been working for years or you're just getting started, you must know about the 401k
Intro:
Welcome back! Another week has gone by and we’re nearly at 150 subscribers - so please share with your friends/family who might enjoy our community of learners and savers.
In this issue we’ll jump into a new topic: 401(k)’s. If this combination of numbers/letter/parentheses is totally foreign, you’re in the right place. On top of that, if you’re rolling your eyes and saying “I’ve been doing a match at my company for days!” You might think you’re all set, but I encourage you to scroll through to learn more about these concepts than you likely know from filling out the ADP or other HR company documents.
Finally, for this intro, I want to introduce our first ever Winnings Survey. It’s short, anonymous, and will help me build better newsletters for you. Fill it out by clicking here.
Background:
As you may have noticed, much of the concepts discussed in these notes cover items that have emerged on the US tax scene in only the past few decades. 401(k)’s only came into being in 1978 - basically toddlers in the history of the USA - in the Revenue Act as passed by congress. The absolutely nondescript name came from the name of the section of the tax-code where the rules of the 401(k) come from, so it’s simply not a name beyond “first amendment” and wouldn’t win any naming pageants.
The brilliance of this addition to the tax code (which I reinforce, has a bad name) was that it enabled individuals to defer their taxable income to a later date by putting some of the money away BEFORE it actually came into their accounts.
Ted Benna (a benefits consultant and tax attorney) actually figured out how to get this 401(k) concept into wider adoption. In it’s initial form, you could save up to 25% of your income (maximum $30,000) in tax deferred accounts. Now that total is bit less, but read on.
Into some more of the nuts and bolts
The premise of using a tax-deferral today assumes that when you withdraw the money you put away in the 401(k) you will be in a lower tax bracket than you are when you put the money into the account. The earliest you can withdraw from a 401(k) without penalty (barring some exceptional cases which are worth looking into) is 59 years old. You also have the option to continue to wait out the withdrawals until your early 70s (that what the law is today, but by the time you get there it might change).
Please remember, the 401(k) money is also managed by the company you work for or by the company that the company you work for appoints to manage the 401(k) plans. Just like an IRA needs to be invested, so does the 401(k). Those investment plans do cost money and you should keep on eye on what the costs are associated with your plans. If you have no idea what those costs are at this moment, I advise looking that up. It’s likely worth paying for, but you should know what it is at this point.
Each individual has a maximum they can contribute to their 401(k) account and today that max is $19,500. Additionally, some companies will provide a match up to a certain percentage of the amount you put in. For example, you might get a match up to 4%, so if you put in 4% yourself the company will contribute another 4% and you’ll now have 8% of what you earn going into an account for your retirement. You can also exceed the match, so if you put in 10% and the company matches up to 4% you’re getting 14% put into your account each pay period.
There are some limits to the total you can contribute to your 401(k) and IRA (traditional/Roth) - please be sure to speak to a tax pro if you’re not sure if you’ve gone over that limit. If you haven’t contributed anything yet, you probably have not gone over.
Takeaway:
Either you already or are now curious if your company has a 401(k) plan. It offers your some tax deferral today and some income in the future as well as a chance to have your employer contribute additional funds to your retirement - all in all not just another brick in the wall. If your investment grows with the market, it’s likely that the 401(k) will help you more than the 5 minutes it took for you to read this note.
For individuals who work at non-profit organizations or in government there are a few other less familiar but similar in terms of outcome mechanisms that we’ll cover next week.
Interact:
If you have the option to have a 401(k) but you have not done so yet, set a calendar reminder to do that this week. Your older self will thank you (or be super annoyed at you if you don’t do it).
If you have a 401(k) at a previous employer and now you have a new job (congrats!) look into combining the plans. It is likely that combining them will save you on the total management fees (often as you get a larger portfolio those fees can go down).
That’s already a lot, but you should probably check how aggressive your investment plan in your 401(k) is at this point in time. You may have set it up with less knowledge than you have now and you’d want to make it more aggressive to maximize long term benefits to yourself and others in your life who you want to benefit from your earnings.
Gratitude:
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