As a current college student or recent graduate, you may be frantically trying to get your life together and find a job in the “real world.” Transitioning into full-on adulthood comes with priorities like living expenses and student loans. Worrying about short-term financial goals often leaves long-term financial goals like retirement out of the picture. Therefore, you may not be thinking about contributing to a 401(k) yet. You may not even know exactly what a 401(k) is.
Have no fear; as a 20-something year old, you still have time to learn and start saving. It’s essential to begin planning to save towards your retirement soon after college. Read on for answers to seven commonly asked questions you might have about 401(k) plans.
What is a 401(k) and a Roth 401(k)?Believe it or not, there is more than one type of 401(k) plan. Here's what to know about 401(k) plan options.
- A 401(k) is a type of retirement savings plan that is offered by an employer. A 401(k) allows for employees to take a portion of their paycheck, before taxes, and save or invest it. This is a great way to begin saving for retirement at a young age.
- A Roth 401(k) is an employee based savings plan as well. However, this type of program is for investments and is based after-tax dollars have been taken out of your paycheck. This plan is for those who think they are going to have a higher amount of taxes after retirement.
Why should I start saving in my 20s?
Most Americans retire in their early 60s. Although that seems far off, beginning to save for retirement when you’re young allows you to maximize your compound interest. Compound interest is the type of interest that slowly builds on itself, meaning that you can start off contributing a small amount but in the long run, have a great deal of savings. Money provides an example that can put into perspective how important it is to start saving sooner: If a person contributes $25 every month to an account that accrues 7% interest, he or she will have $59,890.53 after 40 years. That’s a profit of almost $48,000 – from pure interest.
How much should I contribute to my 401(k) and how?
There is no minimum amount for how much you should add to your 401(k) each year. However, it’s wise to take advantage of your employer’s matching program. A matching program is an amount that your employer contributes to your 401(k) based on your annual contribution. Make sure to discuss what that is going to be so that you can determine how much you should contribute each year. Typically plans will have a calculator that will help you to begin saving the correct amount and tell you how on track you are for retirement! It is effortless to contribute as well; employers will generally go over all 401(k) options when you are eligible or during job orientation.
How much can I contribute to my 401(k)?
The limit, as of 2019, is $19,000 a year. This means that you can contribute up to $19,000 per year into your 401(k) plan; this does not include the employer contribution. With the employer contribution, you are allowed to add a total of $56,000 a year. Once over the age of 50, there is an extra allowance that can be inserted to catch-up on funds. For 2019, this amount is an additional $6,000 a year.
Can I withdraw money before I retire?
By law, withdrawals by active employees are permitted only for qualified financial hardship reasons. These reasons may include paying college tuition, buying a primary house, covering non-reimbursed medical expenses, or other qualified financial hardships.
Can I borrow from my 401(k)?
This depends on your employer. The Motley Fool found that 87% of employer’s 401(k) plans allow for employees to borrow from their balance. However, you will have to pay the amount back along with interest on the borrowed amount. Borrowing from your 401(k) is usually not the best idea because if not paid on schedule, it can result in some hefty fines.
What happens if I leave my current job?
If you happen to leave your job, you typically have the option to rollover your current 401(k) savings into a 401(k) at your next job. You can also transfer it to a retirement savings account (IRA). Do not make the mistake of withdrawing the balance instead of transferring it. Withdrawing this money is a bad idea for many reasons. For instance, you could be facing a sizeable early withdrawal fee and have to pay taxes. This could put a significant dent into your retirement savings.
Even through the chaotic mess of school, graduation, or finding a job, remember that it’s always important to think ahead to the distant future – that includes saving for retirement. It is essential to start when you are young because it can help you maximize compound interest and have more savings when retiring. Financial planning for 20-somethings should not go overlooked.
Disclaimer: The information on this page should not be considered investment or tax advice; talk with your employer’s HR Department about the advantages of participating in a 401(k) plan.
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