401(k) Investing Tips for the New Employee
Written by: Kristy Welsh
Last Updated: August 18, 2017
Congratulations on landing that new job. Before you begin celebrating, you still have some work to do before your first official day on the job. It is important to review your employer's benefits package so you can decide on the health insurance plan that's right for you among other things like: Should you add life insurance? What is a flexible spending account and should you elect to have it? And, finally, the scariest part, creating your 401(k) account.
How Do You Put Together a 401(k) Account?
When you are considering how to go about putting your 401(k) account together, all of the investment data can be mind boggling when trying to figure out where to put your money. In the old days, employees were left to do their own research before investing, which sometimes discouraged people from starting up their retirement accounts. Lucky for you, most companies are adopting all sorts of options aimed at simplifying your experience.
Most folks entering the work force for the first time are in their twenties and the thought of saving for retirement is about as exciting as watching paint dry, but it is something that should be taken seriously. It doesn't really matter how old you are, once you start saving, you've started on the right track towards a better retirement. Even if you're in your forties and have never had a savings or retirement account, you can still do this. It's never too late to begin saving.
Some people believe they'll have to work the rest of their lives so what's the point in saving? The truth is you never know what life will throw your way. It's fun to say you like to live life on the edge but in reality, do you? Taking the time to get your future financial house in order will be well worth it. Heck, even if you do work your entire life, wouldn't it be great to receive a "bonus" check every month from your 401(k) account while you are in your golden years?
Why Should You Save Money in a 401(k) Account?
If you need some more convincing as to why you should start a 401(k) account, hopefully the following facts will entice you a bit. Contributing to your 401(k) lessens the taxes you pay annually. Let's do the math.
Let's say you live in Wisconsin, are single and earn $26,000 per year with bi-weekly paychecks. The taxes taken out of your paycheck are set at: Federal (15%), state (% varies by state), FICA (4.2%), and Medicare (1.45%). Broken down, you earn $1,000 per paycheck minus taxes: Federal = $150, state (6.5%) = $65, FICA = $42 and Medicare = $14.50 for a total of $271.50.
When you contribute 3 percent to your 401(k) (which equates to $30/paycheck), your Federal tax is reduced to $144.50, state to $58.20, FICA to $41.74 and Medicare to $14.06 for a total of $258.50 in taxes. You've saved $16.50. Over a year's time, you would save $429 in taxes because you invested in your retirement. Your retirement account would have $360 in it not counting change in value or interest and dividends you've earned.
Also, by electing to participate in your company's Before-Tax Employee Insurance Benefits and Health Care or Dependent Day Care Reimbursement deductions, you save even more in taxes every year.
There is also the matter of compounding your earnings. If you were to continue contributing 3 percent over the lifetime of your career, your nest egg is on the fast track for growth with little effort on your part. If you always contributed 3 percent and your employer matches 100 percent of your contributions, you get decent annual increases, say 4 percent, and your annual rate of return averages 5 percent, after 30 years, you would have contributed $43,000 to your account, but your account would be worth $180,000.
How to Set Up a 401(k) Account
When you're ready to dive in and get your account set up, we've listed a few options below that could make your experience relatively quick and easy. Like most people, you may not like the thought of tracking and/or managing your 401(k) account. Fortunately, there are options to take care of all this, too! Below are three options that can help make your experience a good one.
- Automatic Enrollment — Some companies automatically enroll new employees in their 401(k) plans. Typically, they elect to defer 1 or 2 percent of your salary into your 401(k). Your contributions are "pre-tax" and are invested into a default fund. The default fund is normally low-risk, like a money market fund. The investment return on money market funds is pretty low, but it's a pretty safe bet and is going towards your retirement. If the company offers a match to your contribution, you'll also get a free chunk of cash contributed to your account by your employer without having to lift a finger. You can always change your deferral percentage or redirect your contributions to other funds at any time if you wish.
- Automated 401(k) Investment Management — Some companies offer the opportunity to turn control of your 401(k) investing over to an automated management system. This takes a little bit of effort up front as you will need to fill out a (sometimes lengthy) questionnaire to identify the sort of investor you are. Based on the information you provide, the system will understand how to invest your money.
How does the system figure out what's right for you? Well, it first determines if you are an aggressive, moderate or conservative investor. From there it determines how to diversify your investments. The multitude of investment options (funds) available to you are grouped by asset class. Asset classes are a way to categorize funds. Some of these are: large-, mid- and small-cap funds, guaranteed, balanced and bond funds among others. The system selects the appropriate funds within some or all of these classes and distributes your 401(k) contributions between them.
On a periodic basis (usually quarterly), your fund performance is evaluated and your account may be rebalanced to keep you on track with your investment goals. This means that on your behalf, the system may redistribute your money between various funds, in your best interest, of course. This management service comes with a price. Typically the fee is based on your account balance. Be sure you weigh in the cost when making your decision whether to opt for the service.
- Target Date Funds — If you really have no idea what to do with the flood of investment information that's available and just want to invest your money somewhere decent and forget about it, you're in luck! You may want to consider target date funds.
Target date funds are the 'set it and forget it' funds that investors can choose based on their retirement year. For example, the target date investment options for investors in their twenties tend to be more aggressive. As these individuals move closer to retirement, the investment options adjust within the fund, becoming more conservative as they approach retirement.
It's easy to choose which target date fund is right for you as the retirement year is included in the name of the fund. Someone in their thirties would probably select a fund that contains 2030 or 2035 in the name. If you are in your forties, choose funds containing 2020 or 2025 in the name. You can actually pick any target date fund, meaning you're not restricted to picking a fund associated with your retirement year. If you're a typical investor however, you'll want to stick with the funds geared towards your age group.
However you choose to get your retirement account going, the most important thing is to get it going. Good luck and happy investing.