You’re lying on a beach soaking up the sun at 11 am. Or maybe you’re traveling with your partner through Europe seeking out adventure. I’m not talking about going on vacation. I’m talking about retirement. That lovely time in the distant future where the world is your oyster and the possibilities are endless. Or are they? That depends on what you save in your 401(k) today.
What is a 401(k)?
A 401(k) is a company-sponsored retirement account you can contribute to that many employers offer their employees. Employees can contribute to a 401(k) directly from their paycheck, and many employers offer a match. This means that when you contribute a percentage of your salary to your 401(k), your employer will match it up to a predefined percentage.
There are two basic types of 401(k)s: traditional and Roth. The main difference between the two is how your money is taxed. In a traditional 401(k), your money is taxed when you withdraw your funds during retirement. For a Roth 401(k), your contributions are taxed now, so you can make withdrawals tax-free in retirement.
We all know we should contribute to a 401(k). But why? Besides having money saved to live your best life when you retire, what’s the benefit to contributing your hard-earned money now when it could be better spent saving for a home or paying off debt. Long story short, your money works harder for you now, so you don’t have to work as hard later.
Here are three things you need to know to take hold of your retirement today.
Start Investing in Your 401(k) ASAP
The earlier you start investing, the better. Your money will work harder for you over the years because of compound interest. Compound interest is when you gain interest on your interest, which results in more money for you. When you contribute to your 401(k), you accrue interest based on where your funds are invested. Let’s check out a few examples:
- You start with nothing in your retirement account and begin contributing $100 a month to a 401(k) today for the next 30 years. Assuming a 7% interest rate, at the end of those 30 years, you’ll have $121,997.10. Your original contribution during that time is $36,000, meaning you gained $85,997.10 in interest.
- Now, let’s take the same example, but instead of $100 a month, let’s up it to $500 a month. At the end of those 30 years, you’ll have $609,985.50. Your original contribution was $180,000, meaning you gained $429,985.50 in interest.
Compound interest is your friend. Think of it as free money. The sooner you start investing, the sooner you can reap its benefits. Try out this calculator to see for yourself.
You Can Choose Your Investments (If You Want To)
When you opt in to your employer’s retirement plan, a target fund is usually identified based on how many years you have until you retire. This slew of investments is predetermined, and there’s nothing you need to do on your end to allocate funds. But did you know you have a choice on where you invest your money? Instead of selecting a premade investment mix, you can choose where you want your money to be invested based on your risk tolerance.
That being said, if you want to choose your own investments, make sure to do your research and consult with a financial advisor to ensure your investments align with your retirement goals.
It Pays to Vest with Your Company…Literally
You know that awesome employer match many employers offer? It turns out it comes with a few strings attached. I’m talking about vesting. Simply put, vesting is how much of the funds your employer contributes to your 401(k) that you own. You might think that as soon as that money hits your account, it’s yours, but not exactly.
Most employer contributions are on a vesting schedule. It could go something like after one year with the company, you vest 20% of your employer match, after two years you vest 40%, and so on until after five years with the company, you own 100% of that money. If you were to leave the company anytime before those five years, you essentially forfeit those contributions and only walk away with your vested percent.
So if you’re considering leaving an organization, be sure to check your vesting schedule and where you fall on their timeline. It may pay to stay an extra month or two if that means you can walk away with more money in your pocket for retirement.