You have a job, you’re getting a steady paycheck and your company just gave you a form to sign up for something called a 401(k) plan. You give it a casual glance, see that you’d have to fund the account with money out of your paycheck, turn the form over and go on with your work.
1. Sign up regardless
Some companies will match the money you put into your 401(k) account up to a certain percentage. Others won’t. If you work for a company that doesn’t provide matching dollars you should still sign up for a 401(k) account because it’s an almost painless way to get started on your retirement saving. And yes, the money will be taken out of your paycheck every pay period but you’re less likely to miss the money because you never actually see it. Even if you start out by saving just $15 or $25 out of every paycheck this will eventually add up to a fairly serious amount.
If your employer does match your contribution you absolutely must sign up for a 401(k)account or you’re basically throwing away free money. As an example of this let’s suppose you contribute $142 a month. If your employer matches to the maximum it will have added another $1704 by the end of a year.
2. Establish automatic increases
Experts at this sort of thing say that your 401(k) contribution plus whatever your company matches should add up to at least 15% of your annual income. If you don’t feel comfortable starting out at that level set up annual automatic increases. For example, you might increase your contribution by 1% a year. If you change your mind for some reason, you can always remove that automatic increase and there won’t be any penalty.
3. Take time to understand the alternatives
Most 401(k) plans limit your alternatives or how you can invest your money. For example, you might be limited to certain mutual funds, stocks and bonds. You may also be allowed to invest only a certain percentage of your contributions in stocks. Take some time to review your alternatives and to do some research. Make sure you understand the differences between stocks, mutual funds and bonds. Mutual funds can be a good choice because they spread the risk as you’re essentially investing in a number of companies. As a general these funds neither increase nor decrease in value as rapidly as do stocks. Bonds pay guaranteed annual dividends. This makes them a very stable investment. If you’ve ever heard the financial expression “coupon clippers” this refers to bonds because in some cases you literally clip a coupon each year and exchange it for cash.
4. Don’t be scared of stocks
You should put some of your money into stocks and some into mutual funds or bonds. If you’re in your 20s or early 30s you might want to heavy up on stocks. Yes, they will go up and down but you probably have close to 40 years before you retire and blue ribbon stocks always increase in value over the long term. Since you have a long-term before you retire don’t be afraid to take a risk at this time. But again do your homework. Choose stocks that are not likely to be terribly volatile. It might be okay to buy stock in some of the high-flying tech companies such as Google or Apple but you might want to balance that off by investing in companies like UPS, Honda and General Mills. These companies might not have the flashy track record of an Apple or a Facebook but they are good value stocks that are almost sure to steadily increase in value over the years to come.
5. Learn what it’s costing you
We don’t know of a single 401(k) plan where there is not an annual administrative fee charged. You should be able to see this on your account statement. However, there may also be fees based on the funds in which you invest. You probably won’t see this on your statement because it’s subtracted from your investment. You may have to call your plan administrator to learn what this fee or fees are. For example, you might find you’re being charged $3.17 for every $1000 you invest in a particular fund. That would be okay because it’s below the average 401(k) fund, which is $5.80 for every $1000 invested. If you find you’re paying more than the $5.80 you might want to take a hard look at the funds in which you’re investing.
6. Think before you leave
Most companies have what’s called a “vesting” date”. If you leave before this date you may lose your employer’s matching contribution. If you consider your current job to be just a steppingstone on your career path make sure to learn if there is a vesting date and when it is before you decide to leave. While this might not keep you cemented to your job it’s something valuable to know. After all, you might learn that if you were to stay just another month you’d get the full amount of your employer’s matching contribution.
There’s the old saying about money that “you can’t take it with you” when you die. However, in the case of a 401(k) you can take the money with you. However, don’t use it for a great island vacation or a new car. If you spend it before age 59 1/2 you will pay a tax penalty of 10%, plus you’ll have to pay regular income tax on the full amount. If your new employer offers a 401(k) plan your best option would be to roll over the money into it. If not, put it in an IRA. Alternately, you could leave the money where it is with your current employer where it will continue to grow although you can’t, of course, add any more money to it. Just make sure you keep some kind of a reminder so that 10 years from now you won’t have completely forgotten about that money. And yes, many people actually do this.
If you’d like to know more about 401(k) plans here’s a video courtesy of National Debt Relief with details about them and how employer matching works …