Candidates have choices beyond the 401K
When markets are tight for talent, employers add more benefits to the menu. (I consider Seattle’s job market to be tight.) These could include free food, entertainment, flexible work schedules and unlimited vacations to name just a few. I found this downloadable infographic What Top Talent Really Wants: The 10 Best Workplace Incentives which HR professionals and candidates alike should pay attention to. This isn’t your parent’s workplace and their employers are rolling over in their grave’s at the mention of unlimited vacations. Just like the buyer should be aware of their options, the millennial candidate should know about their benefit choices.
401K and “The Match”
This week’s post is on the topic of the 401k, explained in lay person’s terms. The benefits in the above-mentioned infographic are relatively straightforward. I find that the 401K match has the nuance that is usually misunderstood by younger generations so I am going to try to give a couple of high-level thoughts on behalf of the company and the employee. Big thanks to one of the smartest guys I know. It would not have been able to be written without the help of a financial guru I really admire and consider a personal friend, @. Seriously, you should follow this guy.
This post came up because of a couple of different reasons. @barstonel and I worked together at a Fortune 100 company and found that most recent graduates were not familiar with 401k’s. They had heard of the term, they knew it is a retirement plan, but they didn’t understand the mechanics and benefits. This makes complete sense. If our company is their first job out of school, they probably haven’t run into a 401k plan before. The schools are not providing education on the 401k and most of us don’t listen to our parents when they tell us to save money. Not fully understanding a 401k is understandable. I just can’t sit back and not do anything about it.
Once a month, I meet with a number of HR execs in the city that are leading the HR teams within their companies. Last month there were several different opinions on “match” or “no match”, but the one thing everyone agreed on was the fact that we all wished someone sat us down early in our career and explained the potential of the 401k. We all wished someone said “DON’T BE A DUMBASS, YOU WILL PARTICIPATE”. I was the only one at the table that had an education in 401K’s, and my education was from family. 401k education wasn’t part of the company culture.
What is this blog post?
This blog post is an introduction to the 401k. I am not going to go into IRA’s or stock options. If you are going to participate in a 401k, because of compounding interest, the earlier you start the better. I want to give folks a foundation on the 401k so they can start their exploration for further information. My goal is to seed inspiration so we ask questions. I am OK with folks not participating (sort of) but as long as it is an informed decision. I also want to show the benefits of misunderstood “the match”.
So who is HRNasty and @barstonel?
@ has a biochem degree, worked for biotech his entire career in finance departments and has his MBA. Yes, he is maxing out his 401k. HRNasty is an HR guy. He is not a CPA, an investment broker and does not have his Series 7. I am just trying to provide information on a very basic and misunderstood benefit that most companies offer and yes, I am maxing out my 401k. When I have worked at companies that didn’t offer a 401k, I pitched the exec team and made sure we did.
What is a 401K?
A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.
Before we go into the mechanics of a 401K, let’s get some basic facts out there.
- 401’s are voluntary. Employees do not have to participate and not required to contribute to the fund.
- This fund is not the companies. The company is not able to access these funds. These funds are the employees. The company pays a third-party to manage the funds on behalf of the employee, but the company doesn’t have access to the funds. They can deposit funds on behalf of the employee but are not able to withdraw.
- You can stop your contributions at any time and you can adjust your contributions at any time. If you are 25 years old, you are NOT locked into 40-year commitment of contributions.
- If you move from one job to another, you can leave your contributions in the original fund or you can move them to your new employer’s fund. No tax penalty.
- We are living longer than we were. Recent graduates are expected to live to be 89 years old. If you retire at 65, we need to sack away enough savings to last us 24 years. If you are living off $50,000.00 a year now you will need at least $1.25M to retire at today’s costs. Remember, our cost of living will probably be more when you are in your 60’s.
- The company offers a 401K as a benefit to its employees. Government regulations allow employees to save up to $18,000.00 tax-free through a 401K, or $24,000.00 for those over 50 years of age. Without this benefit, government regulations only allow savings up to $5,500.00 tax-free through an IRA, or $6,500.00 for those over 50 years of age. Some companies feel that it is their responsibility as an employer to provide a retirement plan for their employees. Other companies try to differentiate themselves as an employer by offering more robust benefits in their competition for talent.
- The employee designates how much money they would like to be taken from their paycheck (pre-tax) each paycheck and these funds are invested and managed by a professional, third-party. The employee has the choice of what funds they want to have their funds invested in. If the employee is unsure, the third-party usually has a simplified formula ANY employee can use to figure out what funds they should invest in. This formula just asks a few questions.
- Years until retirement?
- How much do you feel you will need a year after retirement?
- Is your personality type risky or conservative? (How much risk do you want to take with your funds)
- Folks early in their career will usually wait for their funds in more risky categories (with higher investment returns historically) and those later in their careers will shift to the conservative. The thought is not because of youth being reckless. The thought here is that if something happens to the economy and things go badly, a young person has more time to make up for any negative swings. A person later in their career won’t have as much time to make up losses so may want to play it a little more conservative.
- If we do take the funds out, we pay a penalty. Some 401k’s will allow you to borrow against your funds.
This is what the 401K is all about. This is where the 401k gives the finger to all the other benefits out there. It literally says “I am FU Money”. This is where you NEED to pay attention. Some companies “match” the contributions that the employees make into the fund. Companies that match are usually larger and profitable, but I work for a smaller start-up and we match up to 4%. (Did I say it was competitive in Seattle) So what does this mean?
Let’s say you make $50,000.00 a year. 4% of $50,000.00 is $2,000.00. Spread out over a year’s time, this would be 24 contributions (paychecks come out two times a month) of $83.33.
Over the course of a year, if an employee contributes $2,000.00 into their 401k, at the end of the year, the company will match that $2,000.00 and put that additional $2,000.00 into the fund in the employee’s name.
The employee’s $2,000.00 contribution just became $4,000.00.
So, your $50,000.00 salary just turned into $52,000.00. This is an extra 2-week paycheck!!
You do NOT participate in your 401k
You can spend the money, but remember, this $2,000.00 becomes $1,500.00 after Uncle Sam takes his 25% tax.
Contribute $2,000.00 ($83.33 per paycheck) over the course of a year. If your company matches up to 4% on a $50,000.00 annual salary, they will be contributing an additional $2,000.00. That $2,000.00 contribution just became $4,000.00 and we saved $500.00 in taxes.
You can think long-term, contribute $2000.00 and turn it into $4000.00. OR, you can think short-term, plan to spend $2000.00 and only end up with $1500.00 after taxes. $4000.00 vs. $1500.00, you do the math.
Our personal counsel
If you do not have any other alternative forms of savings (EG: IRA, Stock portfolio, etc.), start a 401k. It is easy, convenient, and tax-free.
Per government regulations, we can contribute up to $18K a year, or $24K a year if over 50 years of age. Early in our career, we may not be able to afford the full $18K, but as we get more seniority and larger compensation packages (thanks to reading this blog), we will be able to contribute more over time. So just contribute what you can. Maybe it is $25.00 per paycheck, maybe it is $50.00 per paycheck. Think about how much we spend on coffee, Coke or cigarettes every 2 weeks. I am not asking you to go cold turkey, but just look for perspective in your spending vs. saving. Your future self will thank you, me and @barstonel.
If we receive a raise or a cost of living adjustment, we can contribute some or all of the additional income into our 401k. We were able to live without the raise, so we won’t miss it if it goes into savings. If we were living on $50k a year and received a raise to $52K a year, use part of or all the $2K increase for additional 401k contributions.
As we look to 2017, think about a New Year’s resolution, think about taking care of your family after you retire, and ask your local finance or HR person about your 401K. Seriously, follow @. You know that guy is maxing out his 401k contributions and skipping out on a new pair of shoes to do it.
See you at the after party,
nasty: an unreal maneuver of incredible technique, something that is ridiculously good, tricky and manipulative but with a result that can’t help but be admired, a phrase used to describe someone who is good at something. “He has a nasty forkball”.