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Transcript

In today’s episode…we’ll be going over the 401(k) savings plan and how you can maximize yours for your benefit. Today we’ll only be discussing the traditional 401(k) plan offered by employers to their employees. We’ll go over other types of retirement savings plans in future episodes. So let’s get started. What is a 401k plan? Why does it exist? A 401k plan is a retirement savings account that is sponsored by an employer that allows it’s employees to defer or send a portion of their salary into this account. And in this account you can choose to invest your money in different kinds of mutual funds and sometimes other options. Usually mutual funds are offered in 401k plans.

You can defer up to $18,500 of your income to the 401k bucket. That reduces your tax liability which basically saves you money on your taxes. One reason I like 401ks is because I’m able to delay paying taxes on this money today to a later time when I’m in retirement and hopefully living in a lower tax bracket. The plan is to build wealth in these kinds of tax-advantage accounts and even taxable accounts, become debt free including the house and have a low cost of living so we’re not taking high amount of distributions from our retirement funds keeping our taxable income in retirement low.

Why do we even have 401k plans to begin with? The reason we have 401k plans essentially was to supplement pensions and social security. Unfortunately over time pensions disappeared and 401k plans have become the main way for employees to build their retirement fund with a company. Still there are some companies that give pensions which is nice. For a list of some of those companies I’ve included a link in the show notes.

A 401(k) plan can be an awesome tool in your financial planning toolbox if you use it the right way. There’s always been this idea that if you save up to the match and work for the next 30 or 40 years you’ll be able to retire with a nice big amount of money. And while that may be somewhat true.

However, I’m BrotherFI which means I want to optimize my path to retirement and bring it down from 30 to 40 years of work to 10 to 20 years of work. This gives me the opportunity to have my own business or even retire when I want to.

This is my personal choice and if you’re like me then we’re headed in the same direction. There’s nothing wrong with working for the same company for 30 to 40 years. Some of us are just interested in working for ourselves.

Who Qualifies for a 401(k)

He or she has reached age 21.

He or she has at least 1,000 hours of service which usually translates to one year.

An employer may consider reducing eligibility requirements, such as a minimum age younger than 21 or a service requirement less than one year and 1,000 hours of service. So check with your employer on any restrictions that may keep you from investing in a 401k plan and see if they can

Why you Want your Employer to Offer a 401(k) Plan

So many of us are retiring without enough money to survive on. With inflation and cost of living always rising it’s important to save as much as you can as early possible.

Some companies may not offer 401ks, but you can change that. There are programs out there with no cost to companies that come and help you establish a 401k plan at your company.

How much to invest?

I’m at a company that offers 6% match and I defer at least 6% of my paycheck for that match. This has served me well. Since starting in 2009 I’ve been fortunate to see about a 43% total return in my 401k. The market has been on a bull run. I don’t expect this to continue, but that doesn’t stop me from continuing to save and invest. It’s about the long term.

Many of you will want to defer more than the 6% and that’s great. Right now the government allows for $18,500 to be deferred in a 401k. So if you have a match at work and you want to save up to the $18,500, figure out how much monthly you have to save to get the match and hit that $18,500 max. Saving $18,500 can be hard. That’s $1,541/month. That’s a lot. But if you can do $300, 500, $1000/month and build up to it each month with raises you should be getting each year then you can get close. Understand this is possible when you learn to budget and live on less. You can earn a salary of $40,000-$50,000 and without debt you CAN put away $1,000/month. This is about how much you want to be in financial control.

401(k) Loan

If you need money from your 401(k) before retirement, there are two ways to get it out: taking a loan or taking a hardship withdrawal. Part of having a 401(k) is the ability in borrowing against it. I am not a fan of borrowing against a 401(k) plan. There are some scenarios where you may need to borrow like to avoid bankruptcy or a medical emergency.

The law used to be if you have an outstanding loan balance and you leave your job or terminated you have to pay within 60 days. Now when you leave a job, you have until October of the following year (the due date of your tax return on extension) to put the money back into your 401(k) or an IRA or a 401(k) at a new employer.

Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10% withdrawal penalty. You do not have to pay the withdrawal amount back.

Check your investment selections

Many choices in a 401k come with high fees. Check fees and opt for index funds. There’s no reason why you should be paying more than 5, 6, or 7 basis points for funds in a 401k.

In episode 5, I explained expense ratios and reasons you need to keep fees low.

Talk to a financial professional if you need investment advice, but as far as education you can reach out to feedback@brotherfi.com. I’m happy to explain expense ratios and why keeping fees low in a 401k is important.

What to do with your 401(k) when leaving your job:

One option is to leave the money there. Managing can be difficult, because you will have to deal with the old company sometimes.

Another option is to move the money directly into your new employer’s retirement plan.

Your third option is to move the money into a Rollover IRA, my favorite. You have more control and can choose your own investments. Do a direct rollover, there are no tax consequences or tax penalties involved.

Assigning a beneficiary

Final point that I want to make is assigning a beneficiary. This almost gets overlooked. You want to make sure that in the unfortunate event of your death that all the money that’s been saved and invested goes straight to a beneficiary of your choice. Federal law says your spouse is automatically the beneficiary of your 401k. Make sure to assign a second beneficiary if possible.