While driving home from work the other day, I heard a report on the radio about how, for many Americans, retirement will be nothing more than a pipe dream, mostly due to poor financial planning. This is sad to hear because you’d like to think that after putting in 50 years of work, more of us would be able to ride off into the sunset, but we can’t because, for the most part, we’re our own worst enemy when it comes to money.
In being our own worst enemy, one of the absolute dumbest things we do is pass up matching retirement funds from our employers. To put it a different way, we fail to take free money from our employers that goes directly into some sort of retirement plan, like a 401(k).
What is a 401(k) and how does it work?
For those of you who don’t know, a 401(k) account is a tax deferred retirement account. To put it plainly, you tell your company to contribute part of each of your paychecks to a retirement account for you, and because you never “touched” the money (remember, your company took it out for you), you do not pay taxes on that portion of your paycheck.
The money you put in your 401(k) account can be allocated to stock, bonds, mutual funds and/or money market accounts; it all depends on the investment company your employer uses as well as how you choose to allocate the money.
Still confused? Let’s look at this example:
I have a monthly income of $1,000 and contribute 10% of that to my 401(k). So, $100 goes directly into my retirement account; only the remaining $900 is subject to tax.
However, when you begin to withdraw money from your 401(k) account upon retirement (or under very specific circumstances), you will have to pay income tax on the money at that point. Thankfully, since the money has been allowed to grow tax free for (hopefully) many years, you will come out on top.
With most 401(k) accounts being tied up in stocks, bonds, mutual funds and/or money market accounts, there are risks associated with this type of investment. You are not guaranteed any return, and may ultimately have less than what you started with.
For example, remember Enron? Many employees of Enron lost all of their retirement when the company went belly up because they had a significant portion of their 401(k) tied up in company stock. So, if you have a 401(k) account or plan on starting one, I urge you to speak with a professional financial planner to get help in determining the correct retirement/investing strategy for you.
Are You Making a REALLY Dumb Mistake?
Okay, so now that you know what a 401(k) is, how they work, and possible risks, what is the best way to maximize your investment? TAKE ADVANTAGE OF EMPLOYER MATCHING!
Many employers will match an employee’s 401(k) contribution, up to a certain amount. And what that essentially boils down to is an automatic return on your investment. In today’s environment, you need to take advantage of any automatic return you can get! Actually, scratch that – not just today’s environment, but whenever you’re investing!
So, what do I mean by automatic return? Let’s go back to the previous example I used, where I contributed 10% of my $1,000 salary every month and assume I also happen to work for an employer that matches every $1 of my contribution with a $.30 contribution of their own.
That means each month when I put in $100 my employer will put another $30 in my account for me.
That’s an instant return of 30%!
Granted, this is just an example, and not every company will match or match this this well, but no matter what your company matches, the moral of the story is it is an automatic return on your investment, and you’d be a fool to pass up this free money – which could eventually mean hundreds of thousands of dollars towards retirement.
So, if you haven’t started a 401(k) account, I highly recommend you go and talk to your company’s human resources department to find out how you go about setting one up. Once you have an account set up, or if you already have a 401(k) account, I suggest you meet with a financial planner to determine the investment options that are best for you.