As the class of 2018 trades its caps and gowns for blazers and cardigans, many of these first-time workers may be grappling with a number of important financial questions.
Balancing student loan payments, rent and happy hour is already a lot to manage in the present, but what about the future? At age 22, even saving for a house might feel like a distant goal — so do you really need to be thinking about something as far away as retirement?
The short answer is yes.
It’s never too early to take steps toward paying your future self. Thanks to the power of potential compounding, saving early and for the entire length of your career can make a dramatic difference at retirement. One of the best ways to do so is through your workplace 401(k) plan, which offers important tax benefits and may come with matching funds from your employer. If you’re brand new to saving in a 401(k), it’s helpful to know the basics.
The ABC’s of your 401(k)First, understand what a 401(k) is, what it’s for and why it’s important.
A 401(k) is a savings vehicle offered by many employers that allows workers to invest for retirement. In 2018, you can contribute up to $18,500 a year (and people who are 50 or over can contribute up to $24,500, as they are getting closer to retirement and may need to play catch-up).
There are a couple of different kinds of 401(k)s — traditional and Roth — with different tax implications, so it is important to understand the difference. Traditional 401(k) accounts are funded with pretax money from your paycheck, which lowers your current taxable income but means you have to pay tax in the future. Any earnings grow tax-deferred over the course of your career, and you pay taxes when you withdraw the money in retirement.
By contrast, you fund a Roth 401(k) with after-tax money, which makes your withdrawals tax-free in retirement, once certain conditions are met. The Roth is a sensible option for those who anticipate retiring in a higher tax bracket than the one in which they begin their career, so it’s often popular among younger workers. Not all companies offer both options, so that’s something to ask about when you are getting ready to sign up.
You may have to waitSpeaking of, know that enrollment eligibility varies by company. Some companies may allow you to sign up for the 401(k) plan on your first day, while others may require you to be on the job for six months or a year before you can participate. Your benefits coordinator will have those details. If you are at a company with a waiting period, identify your eligibility date and create a reminder on your calendar to sign up on or around that day. Again, since invested money can grow over time, the earlier you start saving, the more money you may have at retirement.
If you can’t enroll right away, you may get used to seeing a certain amount on your check every payday, and it might feel like a bit of a shock to see a lower figure once you start diverting dollars to your 401(k). To avoid this feeling and to get into the discipline of saving, I recommend using the time between starting your job and signing up for the plan to begin the habit of socking away money from each paycheck. For example, if you plan to allocate 6% of your salary to your 401(k), put that 6% toward an emergency fund or paying down debt in the meantime. When it comes time to start saving in your 401(k), your other financial priorities will be that much more manageable.
Auto-enrollmentIt’s good to be prepared, but some employers will take the guesswork out of signing up by automatically enrolling you. When companies deploy a feature called auto-enrollment, they withdraw 401(k) contributions from your paychecks as soon as you meet the eligibility requirements. In addition, some employers might auto-increase your contribution rate at particular milestones, like work anniversaries. The idea behind these increases is that the savings rate at which you begin participating in a 401(k) may not be enough to help you meet your retirement goals in the long term; gradually increasing it can help you get closer to meeting those goals. This is important to do even if your company does not offer an auto-increase feature.
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You may get paid to saveOne of the highlights of saving in a 401(k) is that your employer may also put money into your account, matching your contributions up to a certain amount. For example, your company might put in 50 cents for every dollar you contribute, up to 6% of your salary. I’d say that contributing enough to get the full 401(k) match should be your top financial priority, even before paying down debt, because the 401(k) employer match is like an automatic return on your investment that you can’t get anywhere else.
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When you use a 401(k), think of what you’re doing as saving and investing. A typical 401(k) offers a variety of investments to choose from (this is where your contributions are going). These will span a variety of asset classes, like U.S. stocks, international stocks and bonds. When selecting investments for your portfolio, consider how much risk you’re willing to take on. Many people have a higher risk tolerance at the start of the career since they have a long time horizon to make up for potential losses, so they’ll weight their portfolios more heavily toward stocks, which can be considered riskier than some other investments, but can also offer greater opportunity for growth. Over time, it’s common to reallocate your portfolio to include more conservative investments like bonds when you get closer to retirement.
Your 401(k) plan may also include some low-cost investment options, like index mutual funds and exchange-traded funds. These kinds of funds tend to have lower operating expenses, so investing in them can mean putting less of your savings toward management fees and putting more into your account.
You don’t have to go it aloneWhen you’re investing for the first time, it’s natural to have a lot of questions. Fortunately, many 401(k) plans offer some form of managed account service or professional advice. Some companies may offer more holistic financial wellness programs as well. Talk to your HR person or contact your 401(k) plan provider to learn what help may be available for you.
A custom portfolio designed with the help of a financial professional may be best for you, but if that kind of guidance isn’t available at your company, choosing to invest in a target-date fund may also be a sound option. Target-date funds are professionally managed according to your approximate expected year of retirement, and they automatically adjust their mix of stocks, bonds and cash to be more conservative as you get older so you don’t have to make any allocation decisions if you prefer not to.
There is a lot to juggle, financially speaking, when you’re just starting out in the workforce. When you’re facing monthly bills and looming debts, retirement may be the last thing on your mind. But if you can plan for it early and save little by little throughout your entire career, you’ll be that much more likely to retire on your own terms and have the lifestyle you want in your golden years.
Catherine Golladay is senior vice president for 401(k) participant services and administration with Schwab Retirement Plan Services.
The information contained herein is proprietary to Schwab Retirement Plan Services Inc. (SRPS) and is for informational purposes only. None of the information constitutes a recommendation by SRPS. The information is not intended to provide tax, legal, or investment advice; please consult with your accountant or investment adviser for how this applies to your specific situation. SRPS does not guarantee the suitability or potential value of any particular investment or information source. Certain information provided herein may be subject to change. None of the information contained herein may be copied, assigned, transferred, disclosed, or utilized without the express written approval of SRPS and its affiliates. 0718-8H47
