explain a 401k to me in simple terms

[Floridaguy32514]

Okay, so Im 24, have never had any kind of savings plan. in about 6 months I will become fulltime at my employer and be offered the 401k plan

I plan on doing as my partner does now, and depositing 10% of each paycheck into it, I know the company matches, I just don't know how much.

I know the 401k is a long term savings plan. but how bad do I get dinged if i withdraw money early? (can I even withdraw money early?)

I'm a bad saver, I know I am, but the fact of knowing I'll get dinged if I touch the money will keep me from touching it until I know I want something. say I were to keep saving until I had the cash for a boat that I want. is that a sound idea? or will I get hurt so bad withdrawing that it won't be worth it?

 

[bajaunderground]

Re: explain a 401k to me in simple terms

Typically a 401k is taxed at the same rate as your income plus a 10% penalty, if withdrawn early. If you're a bad saver, the 401k is great place to start; however, there are other avenues for investing that require a little more discipline. I would only put into the 401k upto the amount the employer is willing to match. For example, my part time employer matched me up to 3% of my income monthy, so that's home much I put in. I would not use it as personal savings. Not worth the 10% penalty!

Look up Dave Ramsey and his Financial Peace University. The guy's debt-free guru and so much more.

~Brett

 

[GA_Boater]

Re: explain a 401k to me in simple terms

Your employer should have all the plan info. How much they contribute is up to them, there is no fixed percentage. But there are dollar limits how much can be put into it per year. And yes, if you withdraw a portion or all, it is taxable plus penalties except for some very specific reasons.

Like I said talk to your HR department, they have all the detailed answers.

 

[Fleetwin]

Re: explain a 401k to me in simple terms

-Essentially, you put money away today-tax free-up to a certain percent. You're putting money away now while your earnings are higher and your tax rate is higher.
-That money grows.
-At retirement, you can withdraw that money at a much lower tax rate than your current rate.

No offense, but what bothers me is that you are 24 years and don't know what a 401K is. I don't think you are alone by a wide margin. Scary.

 

[agallant80]

Re: explain a 401k to me in simple terms

Oh boy....

OK lets talk 401.

A 401 you can put money away tax free as other stated. So if you make 80K and put 15K in to your 401 your taxable income would be for 65K. It should not be looked at as a short term savings. you should consider it long term savings. The only reason you should take money out of a 401 is because you lost your job and need the money or you want to buy a house. Those two reasons are very open to debate. Reguardless if you take money out of it you will have to pay the normal tax rate + 10% penalty. In addition to the taxes and 10% if you take an early distribution it will be added on to your income for the year. So if you made 80K and you took out 20 to buy a boat it will bump your tax bracket for that year up to the bracket for people making 100K.

My advice (and we all know how good internet financial advice is) would be to put in at least the percent that your emplorer matches and FORGET ABOUT IT.

If you want to know more and index vs mutual funds (you get to pick your investments) watch this.
https://www.google.com/url?sa=t&rct...=xhIdMlQd9AP_Kjhd95Tr6A&bvm=bv.59930103,d.cWc

You will be creeping up on retirement age sooner than you think. Start saving and don't use it for boats or other toys.

 

[Floridaguy32514]

Re: explain a 401k to me in simple terms

No offense, but what bothers me is that you are 24 years and don't know what a 401K is. I don't think you are alone by a wide margin. Scary.

I'm not completely clueless, just don't know the ins and outs of it, I will look into different ways to saving for my next boat, but I do still plan on utilizing this as a savings tool, but the next big question I have, is, what are the ins and outs of it if I leave this employer? The most I see myself being here is another 3 years, I have to get a few issues with my health taken care of and I will more than likely be going to school to become an EMT and leaving here.

 

[MarkSee]

Re: explain a 401k to me in simple terms

...., but the next big question I have, is, what are the ins and outs of it if I leave this employer

You can cash it out and pay taxes and penalty on the money or roll it over to another qualified retirement plan or in some cases, the plan "custodian" (Fidelity, Vanguard, etc.) may let you just leave it with them until you decide what to do with the account though you will not be able to make new contributions to it.

Some employers have a vesting "schedule" based upon years of service with them so even though they may match say 3%, you may not be entitled to the full 3% if they have say a 5 year vesting schedule; you need to check on the plan specifics. Any money you contribute will always be yours.

Since you are still young, you may want to go see an investment specialist on different savings options such as a Roth IRA which is money you have already paid taxes on and the earnings grow tax free so when you withdraw later in life, you have no taxes to pay.

I find it interesting that some folks ASSUME your tax rate will be lower when you get old and retire but no one knows that for sure.
A good mix of tax deferred and tax free investments might be a good way to go for you....it seems to be working well for me.

Here's a link (and there's many others) that will just touch on a couple options but sitting down with someone to go over your situation and goals is always best.

Basics of IRAs | Bankrate.com

Mark

 

[rogerwa]

Re: explain a 401k to me in simple terms

The contributions also reduce your taxable income. If you are with the employer for the long haul taking a loan on it is not a bad idea. My plan doesn't limit to just hardship or education loans. The good part is that the payback and any interest all go back into your account. If you leave or are terminated, it is considered a taxable distribution.

I am not saying this should be used as a little pot of money to loan from, but more to point out there are ways to use those funds without incurring the tax penalty.

Also as pointed out previously, the bet you are making with the 401K is that you will pay less taxes on it at distribution time. My plan offers a Roth contribution option. This allows for all or portions to be taken out post tax. This works for those who want it all in one place or who make too much money to contribute to a normal Roth IRA.

 

[southkogs]

Re: explain a 401k to me in simple terms

Most of what you've got here is pretty good advice: especially the part about doing some more homework. There's plenty to learn out there about investing. Some pointers for you that I haven't seen yet:

1. you'll crush ANY savings plan (short or long term) by learning bad spending habits - learn to control your spending
2. you'll outpace nearly any investment growth with interest on debt - minimize or eliminate debt completely
3. diversify your portfolio as much as you can reasonably - 401k will give you a good line, but not necessarily the best. Take the matching from your employer and maybe a little more if it's a good plan. Then look at a couple of other options to add in.

401k is a sort-of IRA variant. Once you leave your company you can still control it (somehow) by rolling it over, cashing it out or leaving it put.

 

[redneck joe]

Re: explain a 401k to me in simple terms

At a minimum go to employer match. It's free money. No questions there - any more above that has many benefits but its up to you.

Loan if you need/want it and as said you will pay interest, but it goes to you so essentially you are paying yourself, I think you can borrow 50% of what you have saved.

If you leave, you can 'take it with you' if you are vested meaning you own it. Some parts of the company match you may have to stay there for xx years before you own that part.

do it, do it, do it.

 

[salty87]

Re: explain a 401k to me in simple terms

with a guaranteed penalty for early withdrawal a 401k is an awful savings plan if you expect to make that early withdrawal. as others have said, take advantage of the employers match...that's free money. let the 401k grow until you retire. starting at 24 means you could make retirement must easier on yourself than if you don't start until you're older.

get a regular savings account for the boat fund. pay yourself first by putting a percentage of your paycheck aside and don't mess with it. see if your bank will automatically transfer money each month to savings and forget about it.

bad money mgmt and debt, it seems to be the american way but it doesn't have to be.

 

[eavega]

Re: explain a 401k to me in simple terms

At 26, another advantage you have in investing at least as much as your employer will match is compounding. The money saved in a 401K is invested. At your age, and given that you shouldn't be allowed to touch that money for 30+ years, you have a lot of freedom to put your money in the more volatile investment options. More risk, but more gain when the market is gaining. The gains themselves earn interest in later years, even as you move to less volatile investment options.

As an example, I started saving in a 401K at 19 years of age when I got my first job, which paid $8.50 an hour. I invested 6% of my salary, which was the company match, so I was in essence putting away 12% of my pay, which at the time was about $2400 a year. I have steadily increased salary, but my investment amount has always stayed about 10%-15% of my salary. Its effortless since its automatic. You never see the money so it really makes it easy. Anyway, fast forward 25 years later. That original $2400 has grown at an average annual rate of 8%, but for every 8% I've earned on that money, the earnings have earned an additional 8%. That is the magic of compounding. A small sum of money can earn interest, and the interest gains earns interest, which makes the money grow slightly faster. It doesn't seem like much at first, but you let 10 years go by and suddenly you find you have $200K in the bank. You let another 10 years go by, and that $200K has turned into $800K (combination of bigger contributions earning interest, plus your $200K still earning interest). With a little luck in the market, I am looking at having about $3M in my various tax-derferred investment accounts. Contrast that to my dad, who began saving when he was about 50 years old, and here he is at 70 still needing to work because in order to retire he is going to need to have an income of about $40K a year, and with his current savings he cannot stretch it out to more than 6 years. His money just hasn't had enough time to grow on its own.

E

 

[Fleetwin]

Re: explain a 401k to me in simple terms

I'm not completely clueless, just don't know the ins and outs of it, I will look into different ways to saving for my next boat, but I do still plan on utilizing this as a savings tool, but the next big question I have, is, what are the ins and outs of it if I leave this employer? The most I see myself being here is another 3 years, I have to get a few issues with my health taken care of and I will more than likely be going to school to become an EMT and leaving here.

Good, I'm glad you are asking.

If you want to save for a boat/car etc. this is NOT your plan. 401k's are for the looooooong run, as described above.

As for leaving an employer, you can always roll it over to a new plan. There may be a waiting period but it's still there.

 

[gm280]

Re: explain a 401k to me in simple terms

Great advice given above. This is my take on 401ks. And like others stated, advice on the internet is as good as you paid for it. Absolutely put in as much as your employer is matching. That is a no-brainer. BUT, at your age I would also start an individual IRA account and I would make it a Roth IRA too, and here's why. You will get a total tax break on your yearly income with normal 401k's, but not so with Roth IRA's. However, if you can afford one and force yourself to input monthly investment funds, you will end up later in your life with a huge nest egg that will be absolutely tax free when you take any of it out. That is tax free money! A little invested now means you could retire earlier and most of your income will not be taxed one cent. You really need to go and have a section with a financial adviser and understand all your options. It will be time well spent! JMHO!

 

[GA_Boater]

Re: explain a 401k to me in simple terms

You mentioned you want to start a boat fund. If your employer has a Credit Union affiliation, open a CU account. Set up a direct deposit to some money put in the account out of each paycheck. Credit unions have a lot of advantages over banks. And work on your spending and savings habits. It doesn't take long before you start asking yourself where did my youth go. Good luck!

 

[mscher]

Re: explain a 401k to me in simple terms

A 401K is NOT a "savings plan". It is a tax deferred investment plan, that carries a certain amount of risk, to whatever money you (and you employer) put into it. There is always a chance that it might not be there, when you retire, but if something terrible happens to the economy and if that's the case, it probably won't matter anyway, since everybody will be penny-less and fighting each other, over what left in that garbage can.

Otherwise, it should grow nicely over 40 years.

However, for retirement investing, a 401K is about the best game in town, especially for the "average Joe".

Put in all of you can, IMO and save money on the side, for other "stuff".

 

[bruceb58]

Re: explain a 401k to me in simple terms

I have been maxing out my 401K ever since I started working at 23. I always contribute the maximum I am allowed to contribute. Since I am over 50, it's $23K/year right now that goes into the 401K.

Good rule of thumb is that you invest 15% of your gross income into retirement of some sort. More is better.

Never ever withdraw from a 401k including 401k loans. The financial hit is too great.

If your company offers a 401k, there are limits based on your income that may prevent you from also investing in an IRA or Roth IRA.

 

[pikefisherman]

Re: explain a 401k to me in simple terms

Ever thought of putting a little less in retirement ,save for the toys, and find bargains? Retired at 56 last year. Seek out a retirement service most will talk to you for nothing. Don't touch the retirement money at all, put it in and leave it.