I had a good laugh the other day when my cousin asked me: “does a 401(k) mean I get $401,000 toward my retirement?” While this may be a silly question to some, it made sense he would think that. I mean, he is in high school and usually, a number followed by a ‘k’ means $$.
I explained to my cousin that 401(k) is referring to retirement investment plans and 401(k) is just the name of the tax code section for those plans under the U.S. Code. Feel free to check out the link – you’ll have to scroll pretty far to see section (k), though.
All this seems pretty simple, right? It can be. Again, why they don’t teach this in school is beyond me.
So how does a 401(k) plan work? In a nutshell, eligible employers, or your job, allows you (the employee) to contribute some of the money you make toward a retirement savings plan. This is actually very important if you ever want to retire. When you can contribute varies from employer to employer. If you’re questioning whether your employer offers a 401(k) plan talk to your HR department.
When should you start thinking about retirement?
The sooner we learn about savings and retirement, the better. It’s important to know your options and determine when you should focus on different financial milestones. Ideally, those of us who are in our 20s, should tackle credit card debt, student loans, if any, and save up for emergencies first. But it never hurts to learn about retirement and what to expect when we enter that era.
Researching 401(k) plans, along with IRAs (Individual Retirement Arrangements), can get a bit confusing if you don’t know what you’re looking for, so I’m breaking down two common plans:
Traditional 401(k) plans: you can contribute money toward your retirement savings before taxes with each paycheck. You will have to pay taxes when you decided to withdraw that money, however. The catch? You can’t access that $$ until you’re 59.5 years old. I guess that’s something to look forward to on your 60th birthday. If patience isn’t your strongest suit, you’ll get a penalty of 10% on top of the taxes you’ll already be paying. Might want to wait.
Roth 401(k) plans: the money you’re contributing toward your retirement savings has already been taxed and therefore, you won’t owe taxes upon withdrawal. Also – you have access to the account as long as your account has been active for 5 years.
How much should you contribute toward retirement?
A good amount to start with would be 10% of your earnings – you may be able to contribute more or less depending on your expenses. This will vary from person to person.
In my opinion, it’s never too early to plan for retirement. I used to play the “ignorance is bliss” card on retirement, savings, and my future finances but the truth is, I can only do that for so long. However, now that I’m in my mid-20s, I’m facing these adult responsibilities head-on. I figure it’s better to learn and research on what my financial future will look like than to be clueless at 35. It feels good when you learn about your options and you can plan for the best from there.
Check out the graph below that Business Insider created advocating for young individuals to start saving for retirement. This is not to say you absolutely have to start saving now, but it wouldn’t hurt.
Millennials get a bad rep because we supposedly don’t know how to save. Hey Gen-X and Baby Boomers, instead of giving us a hard time, help us advocate for financial education early on. The more educated we are on finance, the smarter choices we’ll make…right?
I explained all this to my cousin the best I could, and needless to say, he’s not so excited about retirement anymore. What misconceptions about finance or life, in general, have you had? Let me know below!
Next, I’ll be talking about another fun topic and something that EVERYONE in their 20s (or even younger) should have: Emergency Savings. Yay!