SkillBuilderDad

Disclaimer: We here at skillbuilderdad.com are neither financial advisors nor professionals. This article expresses the opinions from the personnel at skillbuilderdad.com, and is for inspirational and educational purposes only. The investment decisions you choose to make are 100% YOUR responsibility. Investing of any kind involves risk. It is recommend that you consult a financial advisor before making any trades or investments.

What is a 401(k) and why should I care?

A 401(k) is a fancy way of saying “Piggy Bank For Seniors,” and you should care about it because sometimes there is some free money that your employer puts into it, known as the “401(k) match.” You might be thinking: why create a piggy bank for my old self? Well if you want to have some extra cash when you’re old, it might be a good option to consider.

Ok, so how much should I put into this “piggy bank”, and how much free cash do I get?

Well, that’s all up to you and your employer match (aka: free money). The amount of money that you should put into your piggy bank will vary based on your own personal situation, but let’s consider a few popular scenarios. Scenario 1: you want to retire someday, but you really cannot afford to give up a portion of your paycheck at this point in time, due to a personal situation, or a thing called LIFE. Scenario 2: You want to retire someday, and you’re willing to give up a portion of your paycheck to make this happen. Scenario 3: you don’t care about retiring, but free money sounds good, so why not? Let’s assume in all scenarios that your employer is willing to match 100% (also known as dollar-for-dollar) up to 5% of your contributions. Don’t worry, I’ll explain what this weird lingo means, keep reading.

Scenario 1: I want to retire, but I need my whole paycheck

If I were in this situation, I would say NO to the 401(k) for now, because I have more important things to worry about, such as feeding my family, paying off my student loans, or whatever else gets in the way. It’s called LIFE, and stuff happens. I would not expect to be in this scenario forever, and sometimes I may bounce back into it, but if I need every dollar for my current situation, why give up any of it right now? My goal would be to try and get to Scenario 2 someday soon.

Scenario 2: I want to retire, and I can afford to give up some of my paycheck

Giving up some of your paycheck is taking some crema off the top and putting it into your “Old Person Piggy Bank” if you can afford to do so. If I were in this situation, I would have many options, and would probably do one of three things: The first option would be to contribute just enough to get the “free money”, the 2nd option would be to contribute enough to get the “free money” PLUS some extra savings, and the third option would be to “max out” my 401(k). The first option is easy: If the employer matches 5% of my contributions, then I will elect to contribute 5% of my paycheck (before taxes are taken out) to my piggy bank. This means that if 5% of my paycheck comes out to $100, then my piggy bank will REALLY get $200 put into it, because the “match” will double my contribution. Cool right!? The second option can be really anything above 5% (assuming my match is 5%) within a reasonable amount. If I wanted my piggy bank to be a bit bigger in my sunset years, I could put in say, 10% of my paycheck. If I did this, I would still get the 5% from my employer match, so my piggy bank would be getting 15% (10%+5%) every paycheck (before taxes). The third option of “maxing out” my 401(k) would be to put in the max amount (in dollars) that the government allows per year, divided by number of paychecks per year. To keep the math simple, let’s say that the government allows you to put in $26,000 per year into your piggy bank (yes, there’s a limit), and you get paid every 2-weeks (26 paychecks per year). Your maximum contribution would then be $1,000 per paycheck. If you make $1,000 per paycheck, it would not make much sense to “max out” unless you like having a $0 paycheck!!! If you make $5,000 per paycheck (Lucky you!!), then this would only be 20% of your contributions, and is probably more realistic. Don’t forget about the employer match (free money), which is on top of the “max out” limit, pretty cool right!?

Scenario 3: I don’t care about retiring but free money sounds great

If I really don’t care about retiring, but like the sound of free $$$, then I would do the same as option 1 in Scenario 2: Contribute just enough to get the full match. I’ll go into more detail about the match here, because it can get confusing. If my employer says they will match 100% (or dollar-for-dollar) of my contribution up to a certain percentage, then it’s simple: If they match 5%, I would contribute 5%. Total contribution to my piggy bank: 10% of my paycheck. If my company says they will contribute 50% (or half) up to 5%, then they are really saying: if you put 5% of your paycheck into your piggy bank, we will put 2.5% into it, for a total of 7.5% going into my piggy bank. Not as good as a 100% match, but still better than not getting that free money of 2.5% put into my piggy bank.

If I can afford to “max out” my 401(k), is this best?

Going back to scenario 2, option 3: some would argue this “max out” strategy is the best thing to do, especially if you don’t have the discipline to save money outside of this piggy bank. The “experts” would also talk about how you’ll be in a lower tax bracket when you retire, and so deferring taxes now is better, based on this assumption. Someone once once told me that it’s not good to assume, because it can make an A*S out of U and ME. Bottom line, assumptions can be dangerous, so if it were my money, I would be hesitant to max out my 401(k), because I like to have multiple piggy banks. Having a piggy bank for my old self is great, but I can’t use the money until I’m a friggin’ grandpa. Yes, there are ways to use the money before turning 59.5 years old, but there are penalties and certain rules to follow. keeping it simple, why not just start up another piggy bank (or 2 or 3 or more) outside of the 401(k) that doesn’t come with a list of caveats and penalties? This is where a brokerage account comes into the picture, which can be opened with the broker(s) of your choice, such as Robinhood, ETrade, TD Ameritrade, Merrill Lynch, Vanguard, etc. If you don’t mind rules/restrictions, other tools include Roth IRAs, 529 savings plans, CDs, etc. Then you can look into trading stock and even options, which are a fun new world of investing. Check out our articles on trading options (click here) if you are interested.

Bonus: What’s this whole thing about being fully vested?

Sometimes an employer will want you to put in a few years of service before they allow you to keep all of the money they are matching. For example, if a company says that you are fully vested after 3 years, then it simply means that you will get to keep all of your “free” money they gave your piggy bank, once you have been working for 3 years. If you quit or are terminated before this time period, then they get to keep the “free” money that was matched. After you are fully vested, all the “free” money that flows into your piggy bank is pretty much yours to keep inside your “Piggy Bank for Seniors” so feel free to enjoy it when you’re old. Hey, look on the bright side: it’s free money!