Would you like free money? I am going to assume that the answer is yes. If for some reason you don’t want free money, you can stop reading at this point. And no, this is not one of those signs on the side of the road promising $1000/week investing in real estate or something similar. This is legitimate and about as easy as it comes.
As part 1 of the Intro to Finance series that I am putting together, I’d like to discuss the 401k that most companies offer for salaried employees. To begin, let’s define a 401k. A 401k is an employer sponsored retirement account that allows employees to invest for their retirement on a tax deferred basis. Essentially, you can contribute money before taxes (reducing your taxable income) and then invest that money. Once you reach the age of 59.5 (hopefully well into retirement), you can then withdraw that money and the investment gains without penalty, paying taxes on it when you withdraw. It is a pretty fantastic perk, offering an easy way to lower your tax liability and save for retirement. There is an even bigger perk that most companies offer for 401k plans (2/3rds of companies who have 401k plans, according to a 2009 survey). It’s the employee match.
Essentially, an employer will offer an employee match that looks a little something like this: a 100% match up to the first 4% that an employee contributes to the plan. Or the employer will match 50% of the first 8% that an employee contributes to the plan. In both of those scenarios, the employee gets an extra 4% of their salary put into their 401k plan, but both require the employee to also contribute to the 401k plan. That is specifically what I want to talk about today.
If you company offers you a 401k plan, you should absolutely be using it. If your company offers you a match of some sort, you NEED to be using it. In my mind this is just as important as your debt emergency. It is a raise and all you need to do is save a small percentage of your income directly into your 401k. As a part of the Intro to Finance series, I’ll dive deeper into budgeting, but when you look at your initial budget, you should always set aside money for saving FIRST. In this case, that means you contribute enough to your 401k to get the full employer match before you do anything else with your money.
If you make saving enough a priority, you can contribute up to $19,500 to your 401k for the year 2020. On that note, I want to share with you a quick lesson that I learned recently. In order to get my full employee match, I have to contribute at least 8% of my income to my 401k. Because we have made saving a priority and are privileged with high salaries, I was able to save the max $19,000 before taxes for 2019. However, because I didn’t think ahead, I actually hit that max number at the beginning of December. A lot of companies do not allow for after tax contributions to the 401k. For those companies, that would mean that I could not contribute to my 401k anymore for the rest of the year. That would mean throwing away that employee match and free money for my last month of pay. Luckily, my employer allows for after tax contributions to my 401k and I was able to still receive my full match for the rest of the year. So if you are looking to contribute the max before tax to your 401k, make sure to time your contributions to allow for your full max throughout the full year.