Make the Most Out of Your 401(k)
It's never too early to start thinking about retirement, especially if you can easily start seeing savings using the the right techniques. By starting to contribute to your company's 401(k) plan early and correctly, you can wind up with thousands of extra dollars in your retirement fund. Here are five tips for getting the most out of your 401(k) for a scure financial future.
TAKE THE FREE MONEY
Given the benefits of compounding, even a young guy on a starting salary should try to divert 10% of his paycheck to his 401(k). But if you can’t swing that, the absolute minimum should be whatever it takes to get your full company match.
Spread your savings across U.S. and international stocks as well as bonds. A small allocation to commodities and real estate investment trusts can help spread the risk as well. If you don’t want to pick the funds yourself, just invest in a “target-date” fund, which adjusts the investments according to your age.
It’s difficult to sacrifice income today based on an entirely unknowable future. So here’s one rule of thumb that might help you get your head around the need to save: Financial planners say you can safely draw down about 4% a year from a retirement portfolio without running out of money before you die. That means you’d need $1 million to produce an annual income of just $40,000.
ENJOY THE TAX BONUS
The cash you invest is pretax money, which means a little less is withheld from each paycheck. In practical terms, that means that if you divert $100 to savings, your paycheck is only, say, $70 or $80 smaller than if you hadn’t invested (that $20 or $30, depending on your tax bracket, would have gone to Uncle Sam). Another way to look at it: If you were paying taxes before saving it, you’d only be putting away 70 or 80 cents on the dollar. Just imagine the compounding damage!
INVEST OUTSIDE THE BOX
Some companies (often smaller ones) offer miserable 401(k) plans, with lousy, high-fee funds. If that’s your situation, invest only enough to get the company match. Then open a Roth IRA, which you can do with any discount brokerage firm, such as Fidelity or Schwab, and many mutual fund companies, such as Vanguard. Invest the money in a low-fee index fund. The bad news is that the money deposited into a Roth is after-tax, so you lose that break. The great news: When you pull money out of the account in retirement, you pay no taxes on the gains.