Investing Fundamentals: 401K 👨🦳
The very first investment you should make if you work for a paycheck is in the 401K. What even is a 401K? I’ve never even known what it stands for all I know is its some retirement account… The name is not all that special it comes from the U.S. Internal Revenue Code section 401 paragraph K. Extremely lame name I know. The account itself, not so much.
TAX ADVANTAGES (the whole point of the account)
Stop reading if your employer does not offer a 401K plan just go to my Roth IRA post. If you do not know if they do just ask HR to find out you might even be enrolled without even knowing it (this is a very good thing don’t be mad at your employer). One of the most compelling reasons to invest in a 401(k) is the attractive tax benefits it offers. These tax benefits come from the fact it is a retirement account meaning you cannot withdraw the money until you reach 59 1/2 short years of life. Lets say you didn’t get a chance to read this amazing blog post and it turned out every employer automatically enrolled you in their 401k plan and you wanted to take out the money in the 401k that had grown before you were 59 1/2. This would be very unwise. The penalties are severe. You incur income taxes as well as an early withdrawal penalty of 10%.
WHAT ARE THE BENEFITS?! You may be asking. Well since you are committed to investing your money over the long term you are rewarded with having the ability to invest pre-tax dollars. This means you are able to invest a portion of your pre-taxed income in to the 401k account. Please remember if you make 80k a year you will really make around 59.5k after taxes in Illinois (shedding a tear with you). This means that nearly 25% of your income gets yoinked from you. The 401k allows you to take up to $22,500, which is the contribution limit in 2023, from that 80k NOT the 59.5k. This is money that is usually taken away from us. We want more money. Remember in the first post about investing we learned the power of compound interest. That extra 25% you have to invest really makes a difference.
Employer Match: Free Money!
Another major benefit to using the account which should help you understand or realize how powerful of an investing tool this account really is is the fact that in many cases your employer will match part of your contribution. This means FREE MONEY. Literally free with no catch. Let’s go through a scenario that explains how this matching works. Let’s say you get a 1:1 match up to 4.7%. This means that your employer will “match” every dollar you contribute to your 401k plan up to 5% of your income. The match is not always 1:1 sometimes for example every dollar you contribute they contribute 50 cents meaning you need to contribute more yourself to “max out” that employer match. It is crucial that you contribute enough to get that full match because if you do not you are essentially leaving money on the table.
Automatic Investing
Another great benefit of a 401k account is that is it automatic meaning you set it and forget it. This means that you do not really even need to have amazing discipline, or consistency when it comes to managing your account because a certain amount of money is automatically taken from your paycheck and put towards saving for your retirement. Many people including myself struggle with being consistent. Life can be unpredictable and just knowing in the back of your head that your 401k account is really helping you out in reaching your retirement goals this gives you peice of mind and gives you one less thing to worry about. The final benefit of automatic investing is that it takes the emotions out of it. Sometimes the market may be bad leading tons of people to make bad impulsive decisions and sell their assets which is a horrible thing to do especially when saving long term for retirement. This combined with the fact that you are penalized significantly for withdrawing money before retirement age makes this a perfect account for long term investing.