Last Updated on
For many of us, the 401(k) and IRA investment world is a confusing one. Investing seems extremely complex and everyone has a different opinion on how to invest and how much you should be saving. Today I aim to clear up some of the lesser known facts about your 401(k) or IRA plan.
1. An Employer Match Is Free Money!
If your employer offers a 401(k) or IRA, make sure to find out if they offer any type of a match. Employers that offer a match on retirement contributions do so in different ways. Some will match a flat percentage up to a certain amount (i.e. 3% or more). Another common match is 50% of your personal contributions up to 6% of your salary.
Check with your Human Resource representative to find out what your employer offers. If they match 3%, you need to be contributing the full 3% of your salary to get a 100% return on your investment. By only investing 3% of your salary, you really are investing 6% with the match!
Take advantage of the free money and ensure you aren’t leaving any 100% returns on the table.
2. Compound Interest And Time Are Your Best Friends
When you first start investing in a 401(k) or IRA, it can be frustrating. If you make an 8% return on the $1,000 you have invested, that’s only $80 dollars. Not very impressive when you look at it.
The magic is difficult to see when you start investing. However, give it some time and the compound interest will start to snowball out of control. When you save up $100,000 dollars in your account, suddenly that $80 dollars turns into $8,000 without any effort from you.
Here is a quick visual to show you how compound interest and time work together to make you rich.
As you can see from the above chart, the snowball aspect of compound interest is amazing! The bottom right indicates the largest nest egg at $1.8 million. To get there, you would need to invest $15,000 for 30 years. If you did that, you would only have invested $450,000 of your own money. That means the other $1,350,000 is money you earned in interest!
3. In 2019, You Can Contribute $19,000 To Your 401(k) And $6,000 To Your IRA
2019 started the year off with an increase in contribution limits. Both the IRA and 401(k) limit increased $500 dollars to even out the numbers. If you are a great saver, this was music to your ears!
But wait, there’s more! Did you know that if you turn 50 this year or are over 50, you can put even more money into your retirement accounts? It’s true – if you are 50 or over, you can contribute an extra $6,000 a year to your 401(k) for a total of $25,000! If you are contributing to an IRA, the catch-up limit is an extra $1,000 this year for a total of $7,000!
4. Different Funds Charge Different Fees
All funds within your 401(k) or IRA are not created equal. Each fund you invest in charges a different fee. Some charge fees that are extremely high compared to the other funds. These fees are usually referred to as an “expense ratio.”
For instance, most index funds charge around .06% or less per year. However, other mutual funds may charge up to 1% or more to actively manage your money. If you don’t pay attention to the expense ratios of your funds, you could easily be spending tens of thousands of dollars in unnecessary fees.
5. Your Money Is Off Limits Until Age 59 1/2
A 401(k) is a long term retirement investment. While technically you can make a withdrawal from your 401(k) retirement before the age of 59 1/2, you should avoid this at all costs. If you pull it out before then, you will have an extra 10% tax penalty taken out of it. Giving the government this extra money should be a crime in itself so convince yourself it’s untouchable.
There is one exception to the 59 1/2 rule. If you retire in the year you turn 55 or older, the 10% penalty will not apply. However, if you retire at age 54, you will have to wait until you are 59 1/2 to avoid the early withdrawal penalty.
If you have an IRA, there are more ways to pull your money out before you are 59 1/2. Refer to this article if you are interested in learning about withdrawing from your IRA without penalty. I would advise against it though!
I also wrote an article on Using Your 401k To Pay Off Debt / Pros And Cons. Check it out for more information!
6. Roll Over Is The Best Option
If you have worked for more than one company you may have several 401(k) accounts with varying balances. There are several options available for your 401(k) after you leave a company.
You could take the money as a lump-sum cash payment, you can leave it in the employer’s 401(k) program, you can roll it over into an IRA, or you may be able to roll it over into your new employer’s 401(k) program.
The best option is to roll your 401(k) over into another tax sheltered investment option. Fight the urge to pull that lump sum out and go on a spending spree. We are talking about your retirement, not an easy way to buy a boat.
When you roll over the money, do not accept a check from the previous 401(k) plan. Have them direct transfer the funds over so you don’t get stuck paying any extra taxes.
The more you learn, the more you can change your personal finances and future! I encourage you to check out some of my other articles to continue learning. As of this post, I have over 100 articles I have written on personal finance to help you get ahead!
Arrest Your Debt's Pro Tip:
Track your investments for free with Personal Capital. It's how I track my pension and retirement funds.
Don't Forget To Subscribe For My Latest Posts And Giveaways!
Let me know if you have any questions or if you need anyone to cheer you on! Subscribe to my blog below so you get all my best weekly posts. Keep at it my friends, you work too hard to be this broke!