Alright Millennials, finances, it’s the word that everyone loves to hate (except finance people, yeah I know it actually is a great career choice but some of us really really reeeallly don’t like accounting). It usually implies cutting back on the things you love to do, pinching pennies and building a portfolio when you are literally living paycheck to paycheck! Well, take a deep breath, think of cute puppies and realize that a lot of it is big words made to confuse you…. and this blogger does not know a lot of big words! While I am not a financial consultant I do believe that a lot of financial decisions can be made without them, especially with information being so readily available to us now.
Now if were being brutally honest, most of us don’t like to thank about getting old, I certainly am not looking forward to it! However, what you do financially in your early twenties and thirties or even forties and fifties will decide if retirement will be fun vacations, time with families, volunteering and part time jobs to stay active or working full time well into your sixties and even then not being able to make ends meet. Well, if the first part sounds better here are two financial plans that could make it possible.
The Humble 401 K: Yeah, this one is a no brainer…. sort of, most people know what this is but most people do not understand why or how to use it, that’s where I come in! A 401 K is usually given by an employer who will match up to so much that you contribute into it.
A contribution is any amount you have with-held or deducted from your paycheck that is then placed into this plan. You also usually have to contribute so much before the employer will match the contribution amount.
A Match is the amount the employer will give you after you have made the qualifying contribution. You would need to check with your company to find the minimum needed to get this match, many range in the 2-6% of your paycheck.
A 401 K is also based off of your pretax income which is very important to understand!! This means that when you contribute to a 401 K it is deducted BEFORE your taxes are taken out. This can be great in a lot of ways because it lowers your taxable income meaning you will have more money in your pocket. However, you will pay taxes AFTER you withdraw from the 401 K, this is also very important to remember especially when you consider your age.
Your age says a lot about the plan you should choose, remember, a 401 K can’t have funds withdrawn until the person reaches 59 1/2 years of age (Some hardships and medical circumstances can allow for earlier withdrawals but it also comes with penalty fees which kills your gains!!) and is also based on your retirement age bracket, not the bracket you were in when contributing. So for a forty year old who has been climbing the corporate ladder for years and is close to the top of his game, a 401 k is perfect! his taxable income might go up slightly but not at a huge rate. However, if you are a twenty something year old contributing it might hurt you in the long run as you promote and enter different tax brackets.
So, now its time to put all these words into a picture for my readers to understand ( I know why didn’t you just start there?).
Lets say you are a 20 year old who got a job at a factory, you see that they offer a 401 K and will match up to 10% of your contributions. So, you are making $1000 every two weeks and decide to contribute the 10%. Before you are taxed on the next pay period $100 is taken out. You are then taxed on the $900 at your regular tax rate, lets say 20%. The company matches and you are excited to see $200 in your retirement!
Now. 40 years have gone by, (without compounding to make example easier to understand) You are going to finally withdraw that money!! after 40 years of dedicated contributions you now have $192,000 just waiting to be spent!! However, you did not increase your contributions as you moved up the company and now you are in a 35% tax bracket instead of the 20%. You will withdraw $1000 weekly and pay 35% of that meaning that for every $1000 you with draw you are actually getting $650.
This example does not factor in compounding, increased contributions or other factors but it does show the importance of contribution!! Even if you contributed $50 every two weeks into a 401 K you could have money in the bank for retirement! However, for young millennials 30 to 40 years is a long time to wait for money especially if you want to buy a house, a new car, or just want access to the money you work so hard to make. Thankfully, there are several different options to retirement including the ROTH IRA, which will be explained in part 2 of this series.
Remember, no matter how much it is, put away something! We only have one life and those golden years are a very important time in our lives where we can reap the benefits of our hard work! If you are 40+ you should contribute at least the minimum for a company match, if you are younger certainly contribute but also realize several options are available for a comfortable retirement!