What is it?
A 401k, 403b, IRA are accounts where you can invest for retirement and benefit from tax savings now. These useless names simply come from the tax code that defines them. Well, IRA means Investment Retirement Account. That makes sense.
Why is it so great?
Your deposits are tax deductible. So if you put in $2000 this year, $2000 is removed from your taxable income (in the tax preparation) at the end of the year. Therefore, reducing your owed income taxes. However, you will pay taxes on the gains when you withdraw money in retirement years. There is debate about whether you should pay taxes now and use a Roth IRA or Roth 401k (no tax deduction). You can actually do both. But please don’t worry about that now, its just not worth it unless you have time and are much further along in your retirement savings.
Where is it?
It is an account you open with a financial institution, typically it is offered through your employer. They are not all equal. Just like each bank offers different checking account plans, each institution has different fun options in your 401k and different fees. I have found that generally, the bigger the company you work for, the bigger the institution managing the 401k, and the more choices you have. But you know what, you have zero control over this. Don’t worry about it.
How does it work?
Your money could be invested in a number of asset types including mutual funds, ETFs, stock, and bonds. Your retirement account is useless if you do not actively manage it and plan accordingly. So you need to be involved. Know how much you are contributing every month and figure out if it is enough for your long-term plan.
How Much should I put in?
Aim for a 15% contribution rate. This may be difficult at first. Thats ok. If your company offers to match up to 3%, then you better be putting 3% or you are throwing that money away.
What should I invest In?
I’ve been reading about this for years. Here is what most advice agrees on.
- Decide on your comfortable risk and allocation For example. 70% Stocks %20 bonds 10% Cash
- Pick Mutual funds
- Pick Index fund or funds with a low expense ration 1% or under.
- Pick a Target-Date fund if your program offers it. This is a safe bet.
If you are nervous, just do it. You can always change the funds later as you learn more. Your accounts will go up and down in the long term. This is part of it. So don’t worry about losing value. You WILL lose value and then gain value. Over time, it will go up. That’s it. Do it!