401(What)?

401(What)?

If you’re anything like me, your first “real,” post-college paycheck was more money than your bank account, and you, had ever seen at one time. I felt on top of the world when I saw that there was actually a comma in my account balance. Visions of tropical beach vacations, a brand new Range Rover and bottle service on my nights out danced through my head. However, within no time, my first rent, utility and student loan bills came rolling in. I quickly realized that it would take a few more digits before that comma to truly feel on top of the world.

When I figured out just how quickly my fixed expenses and bills would eat away at my paychecks and that there might be times when there was barely a digit before the decimal point, let alone a comma, I decided to review my pay stub. The lovely Rachel Green from my favorite TV show Friends said it best, “Who is FICA and why are they taking all of my money!?” When you actually look at your pay stub, it is mildly depressing to see how much of your hard-earned money is taken away for Social Security, Medicare, federal taxes and any state income taxes. While it seems crazy to imagine parting with even a single more dollar, I want to try to convince you that giving up a little bit more of your paycheck every month will, ultimately, lead you to long-term wealth and a more comfortable and enjoyable life.

For those of you following my 50/20/30 budgeting method, you know that I stress creating a budget with the dollar amount that remains after contributing, at least, what your employer will match to your 401(k). Now that you have a budget in place that works for you and your lifestyle, we can get into exactly what a 401(k) account is and why it is so important to contribute to one now.

For anyone wanting to grow their wealth and, ultimately, "get rich," there are two secrets: investing and time. Investing and time are the two most effective ways to get rich. While it doesn't sound very glamorous or exciting, a 401(k) account combines both. It is a type of investment account, specifically for retirement, that relies on time to grow. The best part about this kind of investment account is that it takes virtually no knowledge, on your part, of stocks, bonds or market rates to work.

Why should you care about saving for retirement in your twenties? Think of it this way:  we work for just 40 years, in order to fund 70+ years of our lives.

  • Ages 25-65: Working and (hopefully!) saving, 40 years
  • Age 65-95 : Retired and spending, 30 (or more) years
  • Total = 70 (or more) years

70 years is A WHOLE LOT of time. If we don't aggressively put aside money for our non-working years now, it will not be pretty later. Forget being able to spoil your grandchildren, take exotic vacations or retire to a golf course home in Palm Springs if you don't put in the work early. Saving for retirement is absolutely non-negotiable. Everyone needs money to fall back on later in life. And they need a lot of it.

Retirement is fast becoming a growing problem in the United States. It's fabulous that we are living longer, but, what isn't so fabulous, is that we are not prepared financially to handle our longer life expectancy. Retirement savings goals are huge numbers and, oftentimes, big numbers are just scary. They make us stop in our tracks and choose to do nothing at all. If that sounds like you, don't worry. You aren't crazy. It's just human nature. The important thing to remember is that every little bit helps and that just doing something, no matter how small, is infinitely better than doing nothing at all.

By now, you know that you need a lot of money to retire. But, just how much am I talking about? To determine your ultimate needs, decide what percentage of your current income do you need in order to replace not having an income for each year of retirement? Keep in mind that during retirement, many of your current expenses will decrease, or in some cases, disappear completely. For example, you may have paid off your mortgage and, hopefully, will no longer have children to support. However, there will be some expenses that will likely increase, such as health care. A good rule of thumb is that you will need to replace 70% of your current income in retirement. The exact numbers are below:

 

In our twenties, we, generally, have very little extra money to contribute to a retirement account. However, you absolutely must contribute, at a minimum, what your employer will match. If someone was giving away $1000, for free, on the condition that you couldn't spend it until you were 60, would you turn it down? No. That would be crazy. If you don't take your employer match, you are doing the exact same thing. You are literally turning down free money. An employer match is a 100 percent return on your investment. You can't find a return like that anywhere else.

I mentioned earlier that time is the biggest secret to building wealth. This is especially important to remember when it comes to retirement. So often, I hear people make the excuse that they are young and that they will have plenty of time to save for retirement later. However, the longer that you put off saving for retirement, the less interest you will earn and the more difficult it will be for you to save what you need. Not to mention, you will only have more expenses, like a mortgage or childcare, tugging at your purse strings. By starting early, you shortcut the hard work.

For those who are visual learners, the image below explains the time value of money much better than my words ever could. My wonderful mother sent me the below image when I was in high school and it has forever changed my perspective on investing and the importance of starting early.

 

Side note: This graphic is courtesy of Ramit Sethi, one of my favorite financial bloggers and authors. If you are looking for a quick, easy to read and relevant personal finance book to get you started, I Will Teach You To Be Rich is one of the best out there.

The last thing that I want to touch on before you fall asleep or die of boredom (Yes, I realize that retirement is one of the least fun things to talk about) is the pretax component of a 401(k). We discussed earlier the insane amount that is deducted from our paychecks for taxes. 401(k) contributions are made pretax which means you accelerate your earnings by at least 25%, the average income tax rate. Let's say you want to invest $1 in a regular investment firm account. After your income taxes, you would only be able to invest 75 cents of every dollar that you earn. With a 401(k), you can invest the full $1. That extra 25% that you can invest has huge benefits when it is compounded over time.

There is so much more that I could discuss when it comes to 401(k) accounts. I mean, there are entire books written about retirement planning. But, for now, just remember that the secrets to building long-term wealth are investing and starting early. Retirement is a lofty goal, but the most important thing is to simply get started. Take advantage of the free money that your company offers through its match program and keep in mind that, because 401(k) contributions are made pretax, you can invest significantly more of your hard-earned money. As always, please feel free to share any of your questions or comments! Happy Investing!

 

Information Overload : How To Prioritize Your Savings Goals

Information Overload : How To Prioritize Your Savings Goals

What's Your Number?

What's Your Number?

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