Category : savings

When to Start Contributing to your 401k?

At blooom, we are huge advocates for starting to save early and often for your retirement. We are commonly asked the question – I still owe money on my student loans –is it OK to start contributing to my 401k?

Often times people are advised to pay off all of their debts (other than a mortgage) before beginning to save for retirement. I disagree with that strategy.

If you work for a company that offers a pre-tax retirement savings account like a 401k, 403b, or similar AND that company offers a match based on your contributions I think it would be foolish to pass up this free money while you are busy paying off debts. You would be missing out on a guaranteed return on your money by not contributing to your 401k. If you are still saddled with student loan debt, credit card debt, car loans, etc – my advice would be to contribute just enough (and not a penny more) to get the maximum match from your employer. All other excess funds should be aggressively applied to paying down your debts from smallest balance to largest balance – the Debt Snowball method that Dave Ramsey has advocated for years. Once these debts are paid off you can ratchet up your contributions to 10% or more.

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What the heck does “pre-tax” really mean?

You may have heard the term “pre-tax” used in the context of your company sponsored retirement plan (401k or similar). What you may not realize is just how beneficial, and rare, that term really is.

Let’s Assume That Your Employer Offers a Retirement Savings Plan Like a 401k.

These types of tax-favored retirement plans allow participants to contribute some of their salary to their 401k account before taxes are assessed. If you don’t contribute anything to your 401k your friends at the IRS would be assessing taxes on ALL of your salary.

So let’s also assume for this illustration that your salary is $50,000 and that you have elected to contribute 10% of your paycheck to your 401k. That means you are contributing $5,000 (10% of $50,000) into your 401k. To your benefit, the IRS is now only able to tax you on $45,000 NOT your $50,000 salary because your 401k contribution is taken from your paycheck pre-tax. (Note: Pre-tax does not mean you avoid any FICA taxes, e.g. Social Security and Medicare tax, you may owe. FICA taxes are based on gross pay.)

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120% Rate of Return

If your employer offers a pre-tax retirement savings plan like a 401k, 403b, 457, or similar and they offer a matching contribution you may be the lucky benefactor of a 120% rate of return on your contributions.

Let me explain. Lets assume the following:

$50,000 annual salary
Your employer matches 100% of the first 3% of your contribution. So if you contribute 3% of your salary to your 401k, your employer will also contribute 3% of your salary to your 401k.

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The 10% Savings Trick

We hear it quite frequently…”I just can’t afford to put aside 10% of my paycheck towards retirement.” Or sometimes…”We are just barely getting by on the income we have right now.” If you find yourself in this position then I highly encourage you to take a look into Dave Ramsey’s tools and specifically his Core Financial Wellness Program.

But if this article reaches you before you take your first full-time job and before you have car payments, credit card debt, etc. I implore you to implement the 10% Savings Trick. It is incredibly simple in its concept but massively important in its execution. It works like this…The moment you hear what the annual salary offer is (spoken or written) from your first employer – trick your brain into hearing (or seeing) a figure that is 10% less than the actual amount. If you think you hear $60,000 – immediately convert that to $54,000 in your head and base your decision on that adjusted figure of $54,000. Should you decide to accept the offer – in your mind, you will be accepting an offer of $54,000.

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401k Heads to the Gym

It seems weekly that my wife asks me when I’m going to start working out again. I usually have the same old answer, “Soon.” I can assure you that answer won’t suffice for much longer.

Unfortunately the same response can be found for many hard working Americans out there regarding their 401k, “Hey, when are you going to start saving?”

Soon.

If you think about it, your 401k is a lot like working out. Every day you tell yourself one of the following (or all three):

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