Not a chance, if you’re like most people. But you might be doing exactly that with your 401(k). To follow up on our 401Kiki event, which benefited the Edie Windsor Coding Scholarship, we’ve put together this guide to all things 401(k).
Find out how much you can save in a 401(k), what kind of investments to keep in a 401(k), 401(k) alternatives for once you’ve hit your contribution limit (#retirementgoals) and, most importantly — why you should open a 401(k) account in the first place!
Why open a 401(k)?
You’ve probably heard that Social Security trust funds are running out of money. But you might not know how soon that could affect your life.
Unless something changes, Social Security will need to reduce the amount of benefits it pays as early as 2034, CNN reports. By the time you’re ready to retire, there might not be much left –– which is why it’s important to take charge of your own retirement savings.
If you work for an employer, that starts with the 401(k).
At Daylight, we consider retirement savings an LGBTQ+ issue. Hear us out: Wealth management firm UBS reports that LGBTQ+ people:
There are lots of systemic reasons why queer folks are behind on retirement savings. But we didn’t come this far toward equality to not thrive during our golden years!
We can’t say it enough. To live your best life in retirement, you need to make saving a priority while you’re working. That’s where a 401(k) comes in.
So what is a 401(k), exactly? It’s an employer-sponsored retirement account that’s funded through contributions from your paycheck and, if you have this benefit, through employer contributions.
Your workplace might contribute a flat percentage of your pay across the board. Or it might offer a match percentage, where the company matches your retirement savings up to a set percentage point.
If you’re just getting started with a 401(k), setting aside 10% of your gross pay is a good goal. If you earn $60,000 a year, that would be $6,000. Assuming you’re paid twice a month, that breaks down as $500 a month. If your employer matches your contributions up to 5%, that’s an extra $3,000 in your account for the year.
How much can you save in a 401(k)?
The IRS sets an annual limit on 401(k) contributions because they have tax implications. For 2021, you can save up to $19,500 in a 401(k). If you’re over age 50 you can save an added $6,500.
It’s worth noting the tax implications of a 401(k). Your contributions are pre-tax. They don’t just sweeten your future, they lower your tax obligations now. You’ll have to pay taxes in retirement when you withdraw the money, but there’s a good chance it’ll be at a lower rate.
Choosing investments for your 401(k)
As part of your employee benefits package, you’ll receive a list of investments to choose from. These tend to be mutual funds, which are basically large baskets full of stocks and bonds.
Two types of mutual funds commonly offered in employer-sponsored retirement plans, including a 401(k), are index funds and target-date funds (a.k.a. target-date retirement funds).
The right investment for you depends on your preference and risk tolerance. A target date retirement fund is ideal if you tend to be hands-off with investments. The money will most likely grow for you until you need it.
If you’re a cautious investor, a low-risk fund will preserve your savings –– but it may not grow very much. A high risk fund could bring big rewards, but you’ll have to stomach the volatility of big market swings.
You’ll find quizzes that assess your risk tolerance and suggest an appropriate asset mix for you — like this free investor questionnaire from discount brokerage Vanguard. This can help you narrow down the list of funds.
The most common 401(k) alternatives include:
When to open an alternative retirement account
In our 401Kiki video, we covered some of the reasons you might choose another type of retirement account. To expand upon that here, let’s reiterate two things:
If you max out your 401(k) in a year and want to save more, you’ll need another type of account. That’s when you’d think about opening an IRA or Roth IRA. You might also open an IRA if you’d like wider options for investing, whether that’s individual stocks or investments that align with your values.
Experts generally advise that you contribute to a Roth IRA when your earnings and tax bracket are low. If you don’t make a lot of money, you don’t really need to shield your income from taxes.
When you’re in your prime earning years, you might move into a higher tax bracket. Directing more money toward a 401(k) or a traditional IRA actively reduces your tax obligations.
A financial planner can help you understand the nitty gritties of these accounts and advanced topics, like investment strategies.
Are you maximizing your savings?
For now, if you have access to a 401(k) at work, check your contribution limits. Are you saving as much as you’d like? Can you bump up your savings rate to take full advantage of an employer match?
Every dollar you save now helps secure your future. Thanks to the magic of compound interest, even a little amount in your 20s will really add up by the time you reach retirement age.