This week I want to talk about employer sponsored retirement plans, and here’s the short story: If you’ve got ’em, use ’em.
Employer sponsored retirement plans come in several varieties, but today I want to focus specifically on contributory plans, meaning the employee makes contributions (in the form of deferring money from their paycheck to their retirement account).
– 401(k) plans
– 403(b) plans, often called the 401(k) plan for teachers
– The Thrift Savings Plan, the federal government’s 401(k) plan
Simply stated, with contributory plans, you put in some money and your employer (typically) puts in some money, too. This money is invested, and when you retire (or no sooner than age 59 1/2) you can use this money to help cover your expenses. In this case, you take on the risk (and not your employer). This is because, generally speaking, your account balance at retirement depends on how much you contribute, how you invest those contributions, and how those investments perform over time. (The employer is not guaranteeing any fixed return. The balance is what is.)
If you are eligible for this type of plan, here is my advice:
Decide now to defer a set amount of your paycheck (usually you can select this in terms of a dollar amount or fixed percentage) to go to your 401(k), or similar, plan.
Important note: You can contribute up to $18,000 in 2015 (plus an additional $6,000 if you are 50 or older). If you have not contributed this year, talk to your HR department or login to the appropriate site (whatever you have to do) and change your election so you contribute some money from your last couple of paychecks this year. Or, if you’re already contributing, can you afford to increase that amount? If so, do it.
2. Take advantage of your employer match.
If your employer offers a match, make sure you contribute at least the amount needed to receive the entire employer match. For example, if your employer offers to match 3% of pay if you contribute 6% of pay, contribute at least 6% of pay. This 3% is essentially free money!
“But Lucy, you say at least, how much should I really contribute?” Just like the size of your emergency fund, it depends. Hopefully, you now have a better idea of where your money goes each month and now know how much can you reasonably contribute to your plan – so contribute that! And of course, the more money you contribute and the sooner you start contributing the better.*
3. Benefit from pre-tax savings.
For most people, making contributions on a pre-tax basis is the best option. As an example, if you contribute on a pre-tax basis, $1 deferred to your 401(k) plan is $1 saved. If you chose instead to contribute on a post-tax basis, you would first pay taxes on that $1, so it may translate to closer to $0.75 saved (depending on your tax bracket). Additionally, by contributing on a pre-tax basis, you are reducing your taxable income, meaning a lower tax bill. All of this is to say that pre-tax contributions mean more money saved, fewer tax dollars paid, and ultimately more money in your retirement pot.
Here’s a quick example to help illustrate what I’m talking about.
Note: You will have to then pay taxes on this money when you take it out to spend in retirement, but you may be in a lower tax bracket then (because aren’t working and making money). Even so, the power of saving more money now is significant.
Final Reminder: Don’t forget to double check how much you’ve contributed so far this year and then consider increasing that amount for your last couple of paychecks. Be sure to account for your other expenses and your specific situation in regards to credit card debt and an emergency fund. How much do you have to contribute? You of course don’t want to then find yourself not having enough cash to cover your monthly expenses. But if you’ve cut back over the last month or two, now is great time to put those savings toward your 401(k)…before they go to eating out more often or spending more money on useless stuff you can’t even remember buying a few weeks later.
Let me know if you have questions and if I can help you work through your individual situation.
If you’re like me, you are so ready to “Let Luc” over the Thanksgiving holiday! We’re so close!
Happy Monday everybody.
*If you want an example of the power of saving earlier, you can find one here.