We all have a list of things we wish we had been told about money some are obvious some may not be. This is Part 1 of my list of what I wish I knew. Today we cover retirement, 401k and Roth IRA’s.
401k company match
This might sound stupid but if you are not taking advantage of your companies 401k matching you are leaving FREE money on the table every month.
Lets take a person earning $75000 yearly and the company match of 5%. That’s $312 of free money every month your company is giving you. Now we we add compound interest of 7% over 20 years. Your $3750 over 20 years would become 179k if we add your match to that you get 358k.
A 401k account is a retirement account that comes out of your salary PRE taxes the amount you decide, but normally there is a minimum needed from your side to get the company match. You can put a maximum of $29500 (this is the 2020 limit) over the year. As the match is normally per month you need to try and make sure you spread your payments over the whole year, in order to benefit from the match each month.
With a 401k the funds in your account cannot be removed before retirement without paying penalties. However you can take a loan out against a percentage of your 401k, although this is rarely a good idea.
Your 401k is invested in a mix of stocks and bonds. If you want to change this split you can but most people leave it based on an age. With an aged based fund the younger you are the higher % of stocks and the closer to retirement you get the less stocks and more bonds.
A Roth IRA is different type of retirement account it allows you to invest $6000 ($7000 if you are over 50) per year of POST tax dollars. Unlike with a company 401k where your employer decides the company who the 401k is with. A Roth IRA you can open with anyone mine is with Betterment. You can have both a Roth IRA and a 401k.
Roth IRA are different in the sense that you can withdraw your contributions anytime without fees and when you reach retirement age you are not forced to start taking it. Although you might have to pay taxes on any earnings.
The beauty of why retirement accounts grow so much is compound interest. This is where is interest gained on your original principle amount is added to your principal and then earns interest so the following year there is more principal to earn interest on and this cycles continues yearly.
Make retirement your number 1 focus before other investing.
Make your 401k your priority as this is PRE tax dollars which means it’s worth more. If between state and federal you pay 30% tax and earn $75000 yearly, your 5% contribution in your 401k would save you $1150 a year in tax. Although you will pay tax when you withdraw it during your retirement. But it is expected that you will be earning less during retirement so the tax you would be paying is less.