The Questions You Should Be Asking About Your 401k

If you are a young professional like us you probably never put much thought into a 401k plan.  Sure you figured it was part of a good job offer, but now that its finally here you are not sure if you are getting the best deal.  I recently went through the process of setting one up and I will share with you what I learned.

First, what is a 401k?

A 401k is a retirement plan offered by employers.  It works by deducting a portion of your pretax earnings into an investment account, usually a mutual fund or target date fund, of your choice.  More often than not employers choose to match a certain portion of your contributions into the plan.  And while your investments grow you do not have to pay any taxes on them.

When you reach 59 1/2 you are free to withdraw your money without incurring any penalties or fees.

Now for the questions I asked before setting up my account.

What is the employer match?

I surveyed a few friends and I found employers will usually match about 3-6% per paycheck and sometimes ofter an increased rate the longer you stay with the company.  This is rare but if your employer is not matching your contributions I would not even bother.  It takes minutes to set up an IRA at any brokerage which works very similar to a 401k and probably has more options as to where you can park your money.

How long does it take to become fully vested?

This is important as it will tell you when your employer match is received.  I do not plan to leave my company anytime soon, but things happen and you want to know what happens if you do choose to leave.  If you choose to leave before you are fully vested your employer can choose to withhold the money owed to you which can result in a significantly reduced account value.

What are my investment options?

So say you have the job, you are making money, and putting away $200 a month ($400) with employer match for retirement.  It does not mean anything if you do not have good options to park your money in.  Make sure you have a breadth of funds to decide from and ask about management fees because the last thing you want is a high fee mutual fund that doesn’t do anything.

Side note: if you do not have good options you might want to consider making your 401k a portion of your overall retirement portfolio.  For example, I can almost guarantee that most plans have a S&P 500 index tracking fund.  So you could contribute the minimum amount to get the match and use that for your US equity strategy and set up a global diversified portfolio in an IRA wrapper.

Do you offer a Roth 401k?

I actually enrolled in this myself, essentially its betting that you will be in a higher tax bracket come retirement.  The Roth and traditional differ as to when you pay your taxes.  In traditional, like we discussed, you contribute pre tax and defer your taxes to retirement.  Withdrawals are taxed as regular income.  The problem is that a young 20 something year old professional is going to be in a lower tax bracket than a 55 year old executive.  Its like having the money you contributed when you were in a 15% tax bracket is now being withdrawn at 25-30% tax bracket (these are just ballpark numbers to illustrate the point).

The Roth allows you to contribute post tax paycheck money to your 401k and you can withdraw that money tax free in retirement.  In my opinion this is the superior option.  Make a little less today when you are young and it doesn’t matter and make a lot more when you are old enjoying the fruits of a successful career.

I covered mainly the basics here, but this should give you a good start.  If you have any questions, as I am sure you do, feel free to reach out to us and we’ll be more than happy to provide our two cents. You can reach us at founders@themodernpiggybank.com. Make sure to follow us on twitter @themodernpiggy2 and definitely make sure to subscribe on our website! We’ve got new content coming out every day.