***Please make sure to do your research and consult a professional. I am not a professional and content is intended to be used and must be used for informational purposes only.****
The company I work for offers a 401(K) as a retirement benefit for its full time employees. At the time I joined the company, they offered a matching program after one year of service and a fully vested after 4 years. Although the company has changed requirements throughout the years, that is what it was for me when I joined the company. It now offers matching almost right away and no time period for before becoming fully vested.
The matching component is where the company matches what you put into the account up to a specific amount. Vested refers to the ownership of that amount contributed by the company completely and wholly. Meaning, the company can't claw any of that back and you fully own the entirety of the funds.
401(K) ( FYI 403b is very similar)
Before we take a dive into how I have mine setup, let's look at what a 401(k) is. According to the IRS: A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts. Elective salary deferrals are excluded from the employee's taxable income (except for designated Roth deferrals). Employers can contribute to employees' accounts.
A few key components are:
1) Tax deferral- Your contribution is excluded from your taxable income bow but instead pay the tax when you withdrawl. This allows you to utilize those funds take advantage of compounding interest.
2) Retirement Plan- This plan is for your retirement years.Withdrawing the money early, before 59.5, will generally cost 10% + the income tax owed with the exception of a hardship withdrawal. There are also annual maximum contribution limits.
3) Employer can contribute- In my opinion, you should really only contribute if your company is matching because you have other vehicles available with better control to utilize. You should invest up to the amount the company is willing to match and put the rest in another retirement vehicle.
My Setup
As far as my setup, I keep it pretty simple. Your outlook should be long term and you should invest accordingly. Each plan has a set of available investment options that you can choose to put the 401K funds into. They are generally limited and is why I feel you should only put up to the match amount. I fund the account up to my company's matching amount to take maximize the benefit. The rest of the amount you want to put toward savings, utilize in another retirement vehicle such as an IRA.
Most programs have a target date fund based on your retirement year. You can buy into that and it is rebalanced to fit the needs as the retirement year comes. In short the tend to move money out of stocks into safer investments to balance risk. I think these tend to be to safe as retirement approaches. I put my funds in a target fund 10 years out from my date to be a little more aggressive but still allow some safer investments. You should follow the same rules with general investing, if you need the money in the next 5-10 years move that portion to a safer investment, otherwise keep it in the market.
The rest of my funds are in an index fund. I chose an index fund that mostly mirrors the S&P 500. They have funds that track various indexes and a few options for industries such as real estate. I believe in concentrating on a just a couple funds and sticking to that instead of putting money in a bunch of funds. Pick your top ones and focus on those. These funds are already generally diverse and reflect the market you are interested in. Over diversifying can be damaging by limiting your upside.
I evaluate the funds and distribution every quarter but rarely make any major changes. I have a few times moved the funds from one investment to another due to it being discontinued or a new better option being added to the program.
When you leave your company, remember to move the funds in the account. Most companies give a period before you become liable for the expense of your account and that will diminish your returns. Plus without the match you can take advantage of other retirement plans. Make sure you don't withdraw your funds but transfer it directly to a new retirement plan to avoid paying the additional taxes.
Remember, when it comes to investing and taking care of your income to always pay yourself first. Future you will thank you. Your future peace of mind is much more valuable than that latte or night out. Although those are important, first make sure you are setting yourself up for long term financial stability. I setup my accounts to auto deposit or transfer so I don't even see these funds each pay period. Whenever I get a raise so does my investment accounts. Start investing early, the compounding factor is real and delaying will have a big impact on the long term results.
Summary:
-401k is a retirement program with tax deferral, early withdrawal tax, and maximum contribution limits
-Take advantage of it up to the matching amount from your company is offering, put the rest of your budgeted retirement money in another account
-keep it simple and invest in one or two funds and when you leave your company move the funds
-PAY yourself FIRST and start EARLY and consistently.
-Your company may offer a 403(b) and is very similar and can follow the same strategy.
