Friday, April 11, 2008

Thursday (Friday) Money Tips: 401(k) Edition

Each Thursday, Ms. Moneypenny publishes 5 money-related tips. If you have tips, please leave them in the comments, and I will collect them for later use in my blog.

I'm a little late this week, but here they are. This week, I've decided to focus on retirement planning. My husband and I are in our mid-thirties, and these days, we're watching our parents start the retirement process. Sander and I have been saving for retirement for a while, but it's really hard to put our fingers on what we might truly need to save for retirement.

More on that later, I'm still in the research process of how to *really* calculate what you need from 30 years away.

In the meantime, I've come up with some personal rules of thumb around retirement savings.

So here's my recommended steps to take with regards to saving in an employer-sponsored 401(k) - whether you are just getting started, or just want to check yourself.

1. Save in your 401(k) first before any other options.
For those that have them, a 401(k), named for the section of legislation that created it, is the best savings options. There are two kinds, a Roth 401(k)k, and a traditional 401(k). Traditional 401(k)s are pretax savings that reduce your taxes now. Roths are post-tax, but are not taxed when you withdraw them. Based on the reading I've done, I'd go Roth if it is available, and if you are 45 or under when you start it. You'll lose some tax benefits now, but I'm going to guess that our relatively low tax rates aren't going to stay that way forever. If you don't have a Roth available, go traditional.

2. Save in your 401(k) even if the choices aren't great.
Why? Several reasons. It's coming out of your check, so you won't see it. Also, even if you don't have a Roth 401(k) available to you, the traditional has great benefits. And employers typically match between 3-6% of your contributions. Never walk away from free money.

If your choices aren't good, you may want to contribute up to the match, and then save in other vehicles, but even when I had a not-so-great 401(k), I saved as much as possible in there. Then when I changed jobs, I rolled it over into an IRA.

3. Make your goal the maximum contribution.
For 2008, the federal maximum contribution to a 401(k) is $15,500 if you are under 55 years of age. That's a lot of money. Even at a pretax contribution rate, if you are taxed at 28%, that's still $11,160.00 that isn't in your paycheck.

But I said make it your goal, not do it tomorrow. If you aren't saving anything now, contribute up to the employer max. And then every 3 months, up it another 1%. Keep going until it hurts. Then stop. Every time you get a raise, go up another 1%. Do this at 25, and at 40 you may be saving the max without noticing the impact. Taking 10 or 15 or 20 years to get to the max is not unreasonable. Set the goal and start moving towards it.

4. Realize you are in this for the long haul.
You aren't saving for tomorrow or next week. You are saving for something 20, 30, or even 40 years away. So the best advice I can give is to put your money into some low-fee, high rated funds (you can check your fund ratings at and then ignore it. Once a year, go back and check the fund ratings and rebalance if you need to. But leave it alone, and let it grow.

5. Don't EVER withdraw, unless you are in danger of homelessness or starving.
This money is not for fun. It's to keep you off welfare and from eating cat food in old age, not for a kitchen renovation, or dream vacation. If you save hard, you may get the trip to Tahiti too, but if you keep cashing it out, not only will you pay a 10% penalty and income tax, you'll have years of unrealized gains just wash away on that beach you are dreaming about. You want a good life when you have time to enjoy it, don't you? Don't screw yourself out of the future.

Next week, we'll talk about IRAs.

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