You probably heard the financial term 401(k) thrown around during employee orientation, but had little to no idea what it actually stood for. We’re right there with you—which is why we went looking for professional advice on the matter. From the most basic definition to making the right decisions, we explain it all with the help of CEO and Co-Founder of blooom Chris Costello.
Costello helped found blooom on the belief that professional 401(k) help should be smart, simple, and available to all Americans—even us twentysomethings who are digging to the bottom of our purse for change to support our morning Starbucks habit. Often, financial management and investment advisory has been only for the uber-wealthy—Costello knows, he was one of those financial planners to the rich for two decades—but he and blooom hope to make it accessible for the under-served… a.k.a., all of us.
So if you’re currently enrolled in a 401(k) or you’ve never even heard the term before, let us answer all your deepest, darkest questions about using an employee-sponsored 401(k), what Costello calls one of the “worst-named savings vehicles out there.” (We agree!) Take notes and get ready to take back your financial future.
OK, seriously, what exactly is a 401(k)?
For complete newbies, a 401(k) is an employer-sponsored savings plan that gives you a tax break on money you set aside for retirement. It’s basically a way to defer a percentage of your current income into a savings account that’s intended to grow over your working years, with the hope that it becomes large enough that (one day) you can stop working—a.k.a., retire, hopefully to a tropical island flush with frozen drinks.
When can I enroll in a 401(k)?
If you missed the initial email from HR, don’t sweat it. (We know, being a new employee means a lot of new emails.) Unlike other employee benefits, such as insurance, you can enroll in a 401(k) year-round.
Some employers automatically enroll new employees in the company plan with default investments, but others don’t. Your company may also have a waiting period before new hires can enroll. So, be sure to check with your employer so you can cash in on those tax-free savings ASAP.
Retirement is so far away. Why do I need to start thinking about it now?
Fresh out of college, retirement is the last thing on your mind. Even in your 30s, it seems like a million miles away. But saving for retirement is less about planning your future than simply being prepared for all the unknowns.
“Putting yourself in a position where you no longer have to show up to work every day, even though you may love your job, gives you the power to make that decision,” Costello says. Unless you become a social media billionaire or hit the jackpot (don’t hold your breath), you’re going to need a retirement nest egg to fall back on. It’s both a comfort and an empowering force.
Still, does a 401(k) give you visions of a far off land when you’ve got blue-gray hair (not the trendy kind) and are playing shuffleboard in your velour tracksuit at your retirement community? Costello has another way of looking at your 401(k).
With these savings, “You’re now at a point, somewhere down the road, that you can stop doing what you’re doing,” Costello says. “You can travel the world, you can take a two-year-long sabbatical, you can volunteer for the rest of your life, you can start your own business, whatever the case is.”
How much do I really need to be putting aside in my 20s?
On top of making rent, paying your phone bill, and grabbing your venti vanilla latte with no foam and one pump of hazelnut every morning, we know the last thing you’re looking for is another financial commitment, especially when you don’t have a lot to invest in the first place. If you’re still trying to get your financial footing, focus first on making sure your company offers a 401(k) option. Not sure? Take 30 seconds and find out if your company makes any type of a matching contribution.
“If your company matches, you absolutely have to make sure you’re contributing just enough to get that company match. Because that is 100 percent free money,” Costello says. Companies that offer this benefit match your contributions, partially or in-full, up to a percentage of your salary. That match can vary from 50 percent to a generous 100 percent of your deposits, with the contribution limit ranging from two to six percent of your pay.
Now don’t go putting half your paycheck into a 401(k) fund. There’s also a maximum annual employee contribution set by the IRS each year. If you’re under 50 years old, the limit is $18,000 per year; after 50, it increases to $24,000. Bonus: Employer matches are on top of that.
But I just started paying off my student loans…
So what’s more important: paying off current debt or saving for retirement? Before you can do either, you need to set up an emergency savings account at the bank with a couple months’ worth of living expenses (food, rent, and insurance). This account is only for genuine emergencies like job loss, an unexpected medical problem, or a car issue—not for that new pair of boots you’ve been eyeing.
Next, tackle bad debts like credit cards and student loans. “If your your company offers a 401(k), but doesn’t make any matching contributions, permission given to not even participate in that 401(k),” says Costello. “If you’ve got credit card debt or student loan debt you should absolutely be putting every penny toward attacking that crappy debt.”
Get yourself debt-free, then you can really start saving for retirement.
However, if your employer does match contributions, take full advantage. Find out what that match is, and don’t put a penny more into your 401(k) than what you need to. Use every bit of leftover cash to attack that student loan and credit card debt.
How do I know what to invest in?
Even though 401(k)s are provided by your employer, they aren’t managing it or making sure your account has the best investments for you. That’s up to you.
There are an overwhelming amount of investment options in a 401(k), mostly made up of mutual funds with a diverse combination of stocks, bonds, and cash. You choose your investments based on a particular strategy or how much risk you want to take.
Your company’s default investment option will likely be a target-date mutual fund with a mix of investments, which automatically rebalances to reduce risk the closer you get to 59, the retirement age. This may be convenient, but it’s not always the best choice.
Does this already sound overwhelming? Frankly, Wall Street wants it that way.
Because most of us don’t have $1 million in our 401(k), can’t afford a professional financial advisor, and don’t feel comfortable managing our own investments, we are left to blindly guess where to put our life savings. But, “there are certain things in life that you shouldn’t DIY,” says Costello.
That’s where blooom comes in. With blooom, you don’t have to have a huge account to access financial help; it’s available to anyone. If you have a 401(k) right now, you can get a free assessment of your 401(k) health online, including what fees you’re paying and investment advice specific to your portfolio mix. For $10 a month (as much as your Netflix subscription) blooom will research every single fund in your 401(k) and choose the best portfolio for your situation, making adjustments as market conditions change. With more than 15 years of professional financial planning on your side for such a small price, what more could you ask for?
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Can I take money out of my 401(k) for an emergency?
Don’t even think about it. If you make a withdrawal, usually before age 55, you’ll be hit with extreme penalties: a 10 percent penalty on top of full income taxes. You should have emergency savings separate from your retirement savings.
According to Costello, “The mistake people may make is they might start putting too much money in their 401(k) prematurely. I know that sounds totally contrary, but if you’ve got debt, pay that off first, then set up an emergency reserve, then you can go gangbusters on contributing to the 401(k).”
I have a 401(k) but I really want to accept a job offer at another company. What happens now?
Yo do you, boo boo! When you change jobs, you have several options for your 401(k): You can leave it behind with your old employer, move or “rollover” your contributed money to your new company’s 401(k) plan, or rollover your balance to a traditional IRA.
Depending on your current company’s matching plan, you may have to wait for their contributions to be vested (put in your account) before you roll it over. Whatever you decide, “don’t cash the damn thing in,” Costello warns. Your 401(k) will lose its tax-deferred status and you’ll get clobbered with another 10 percent penalty fee, wasting all your hard-earned dollars.
Okay, but what's the catch to a 401(k)?
One of the dirty secrets about 401(k)s are the hidden fees. And they’re called “hidden” for a reason. The industry has done a great job of concealing these fees as management fees or expense ratios, with many people under the assumption that their company is paying these fees, but that’s not always the case.
If you review only one thing about your company 401(k) plan, make it investment fees, and prioritize lower-fee funds over all others. Blooom can also help manage your investment fees, saving you hundreds of thousands of dollars in lost retirement funds over time.
When changing jobs, be sure to compare the fees. “It is the Wild, Wild West in terms of hidden fees, and they vary tremendously,” says Costello. If your previous employer has low fees and a good selection of funds, and you new employer is charging higher fees, that’s when you’d want to leave your 401(k) behind and vice versa.
Now that you understand all the ups and downs of this terribly-named account, take advantage of this amazing employee benefit and set yourself up for a successful retirement, whether that’s the community Bingo night or backpacking across every continent. You’re empowered with a strong, managed retirement savings account backing you up.