Why You Should Care About Your Retirement Now
Hey there, future retiree (yes, even if you just started on your career path). While retirement might seem like a distant dream, trust me, it sneaks up faster than you think. Let’s not end up with a big regret of why you didn’t take advantage of your option to participate in your employer’s 401(k) or 403(b).
It may sound really boring, or maybe you’ve just never taken the time to understand them. These retirement accounts are one of your opportunities to building wealth, lowering your tax burden, and ensuring you can retire in style, or even exit the workforce sooner than you think (depending on your lifestyle).
So, What Are These Magical Accounts?
In a nutshell, a 401(k) is a retirement savings plan offered by for-profit companies, while a 403(b) is the non-profit equivalent. They both work in similar ways, allowing you to sock away pre-tax dollars from your paycheck into a special account. This money then gets invested, grows over time, and hopefully becomes a hefty nest egg by the time you’re ready to hang up your work hat.
The Perks: Why You Should Be Best Friends with Your 401(k)/403(b)
1. Free Money (Kind Of):
Many employers offer a matching contribution. This means they’ll match a percentage of the money you put into your account. It’s like getting a bonus just for saving for retirement. This is where you also may hear statements like, “you’re just leaving money on the table if you’re not taking advantage of the employer match.”
Also, we should add some details about a vesting schedule – There are two main types of vesting schedules:
Cliff Vesting: Taking the Plunge
Imagine standing on the edge of a cliff, ready to take a leap of faith. That’s cliff vesting in a nutshell. You get 100% ownership of your employer’s matching contributions, but only after a set period of time, usually 3 years. It’s an all-or-nothing deal.
Example: Let’s say your employer matches your contributions dollar-for-dollar up to 6% of your salary. If you leave before your 3-year cliff, you forfeit all of that free money. But if you stick around for the full 3 years, you suddenly own it all – like diving into a pool of cash!
Important Note: Even if you leave before the cliff vesting period, you’ll still get back your own contributions to the plan. You just lose out on the employer’s match.
Graded Vesting: Climbing the Ladder to Ownership
Think of graded vesting as a staircase to full ownership. Each year you work for your employer, you climb another step and earn a percentage of your employer’s contributions.
Example: A common graded vesting schedule is 20% per year for five years. This means that after one year, you own 20% of your employer’s contributions, 40% after two years, and so on, until you reach 100% ownership after five years of service.
Why It Matters:
Protect Your Retirement Savings: Vesting ensures you don’t lose your hard-earned employer contributions if you leave your job before you’re fully vested.
Understand Your Benefits: Knowing your vesting schedule helps you plan your career moves strategically and maximize your retirement savings. Your employer’s vesting schedule is outlined in your plan documents. Don’t hesitate to ask your HR department for clarification – it’s your money, after all!
2. Tax Advantages:
The money you contribute is usually pre-tax, meaning it’s deducted from your paycheck before taxes are calculated, lowering your taxable income for the year. This is a significant advantage, especially if you’re in a high tax bracket now. Plus, your investments grow tax-deferred, which means you won’t owe taxes on any gains or dividends until you withdraw the money in retirement. And, as an added bonus, you’ll likely be in a lower tax bracket then, saving you even more money.
3. Automatic Savings:
Contributions are automatically deducted from your paycheck, making saving effortless. It’s like having a personal finance fairy who takes care of your future self while you sleep.
4. Investment Choices:
Most plans offer a variety of investment options, from stocks and bonds to target-date funds that automatically adjust your investments as you get closer to retirement. You can tailor your portfolio to your risk tolerance and goals. Many employer run plans will also let you make changes to your portfolio as you need to. I’ve personally done this with my own where I decided to shift out of one mutual fund to another that was a bit more aggressive and was historically giving a higher return.
5. Compound Growth:
The earlier you start saving, the more time your investments have to grow and compound, thanks to the magic of compound interest. It’s like planting a money tree that keeps on giving. That first thousand may seem touch, and then the next $10,000. However, once you reach that $100,000 mark (and you will), it’s at this point you start to really see the benefits of the compounding effect because your money has the ability to multiply more quickly.
6. Portability:
If you change jobs, you can usually roll over your 401(k) or 403(b) into a rollover Individual Retirement Account (IRA) or your new employer’s plan. Your retirement savings can follow you wherever you go. This is something that I have also done over the years. Be sure to contact a tax professional if you are unsure how to do this.
How to Get Started: Your Retirement Savings Cheat Sheet
- Enroll ASAP:
If your employer offers a 401(k) or 403(b), sign up as soon as you’re eligible. Don’t miss out on those sweet matching contributions. Remember, leave no money on the table. - Contribute Enough to Get the Full Match:
Find out how much your employer will match and aim to contribute at least that amount. Also, make sure to pay attention to the vesting schedule. - Choose Your Investments Wisely:
Don’t just throw darts at a board. Research different investment options and choose ones that align with your risk tolerance and long-term goals. If you’re unsure, seek advice from a financial professional. This small investment of time and money could net you a much larger return. - Increase Contributions Over Time:
As your income grows, it’s easy to have lifestyle creep and you’re continuing to spend more on non-essentials. If you’ve been doing just fine on your current salary this is really the time to gradually increase your contributions as more money comes in. Even small increases can make a big impact over time. - Rebalance Your Portfolio Regularly:
Make sure your investment mix stays aligned with your goals as you age. Even though the withdraws are automatic from your paycheck, it doesn’t mean that you shouldn’t log into your account on a regular basis to see how your money is growing (or not).
Remember, your retirement isn’t just about kicking back and relaxing (although that’s certainly a perk). It’s about having the financial freedom to live life on your own terms, pursue your passions, and enjoy the fruits of your labor. So, start investing in your future today – your more experienced self will be grateful.