When it comes to financial literacy we always encourage people to be educated as much as possible or at least to understand where is your money going, being able to budget right and save. These are the 3 pillars and they are pretty easy to follow. Understaing your 401K or any other employer sponsored plans might be a bit more complicate but actually not very hard. Here is breakdown of what to know about your current 401K.
Understand the employer’s benefit.Do they offer a match?If so, how much?
A lot of times, an employer will contribute a certain percentage but you have match that contribution. Our typical recommendation to clients is to at least get your free match/money, from there. After that, you can budget accordingly for your other financial goals.Contributing to retirement has become a necessity, it’s not a luxury item, pensions are dying out so we need to make sure we are contributing and looking out for our future.
Understand your contribution type. Note: Not every plan offers both. Speaking of contribution types, understand what is offered and how it can affect your own personal paycheck.This can also help you out with annual tax situation, or at least control it.
Pre-tax vs Roth/After-tax contributions.
This is often a heavily debated topic, but let’s cover the some of the basics. Pre-tax comes out of/affects your GROSS income, which means that this is much less noticeable to your take home pay.The downside is that it will be taxed as income when you do go to withdraw from it in retirement.Roth/After-tax has potential for upside in the long run, as your withdrawals will be tax free in retirement.However, your paycheck will take a bigger hit now.
-Pre-tax will make your paycheck feel “bigger” and lower your taxable income.
-Roth offers tax free benefit in retirement, but less money NOW since you’re paying taxes on it.
-Either way you pay taxes, it’s now vs. later
Understand the fund lineup. Every plan is different and offers different options/funds.Most commonly you will see a list of mutual funds to select from.How and what you select really depends on how involved you want to be with your plan.
Hands on vs hands off.Do you want to be heavily involved?There are lots of allocation models to follow if you do want to be hands on. Hands off investors can utilize retirement date funds, typically based on a date which you would turn 65. These funds are on a glide path, which means you have to do very little in terms of monitoring/managing it.