When we get our first grown-up jobs and people start talking to us about 401Ks, IRAs, and retirement funds, we’re all probably like, “what? I’m sorry, I don’t speak that language.” Because honestly, who knows what any of that nonsense means anyways?
But in reality, we all know it’s probably a good idea to try and crack that code, because no matter how far away it might seem now, retirement is something we’re all going to have to deal with someday and we need to start saving. No worries, though, we’ve got your back — we’re going to answer all of your questions about how retirement funds work.
What is a retirement fund?
Retirement funds are like special bank accounts you start when you begin your full-time career and cash out on when you finally retire. These are so, so important because whether you like it or not, everyone is going to retire someday and everyone is going to need money at that point. Super mega bonus: this money usually has certain tax exemptions or tax policies that benefit you.
How do I start a retirement fund?
People usually start their retirement funds when they start full-time work. As a part of many company benefits packages, employers will include a 401K option for you.
There are a few exceptions to this general rule. First, some companies will offer you a retirement plan, but it won’t be called a 401K. For example, if you work at a non-profit, you’re probably going to have a 403(b). This is because these kinds of companies have different tax arrangements with the government, so the fund is set up a little different.
Another exception is at really new companies. Some start-ups (that are really in the start-up stage, not in the “look at my fancy Google campus” stage) can’t afford to arrange a 401K for you right now. Others can, but need you to hang around at the company to 6 months or a year before that benefit kicks in. Don’t freak out though, because there are some options for people in this situation, too, and we’ll discuss them in a minute.
With a 401K, you elect to have a certain percentage of your paycheck sent right to your retirement fund so you start accumulating savings. What’s cool is that this money is automatically taken from your paycheck so you don’t have to remember to transfer it (or worry about accidentally spending it).
Another cool thing about 401Ks is that the percentage you’re contributing is determined before your taxes are taken out. For example, if your paycheck is set to be $1,000 before taxes, and you contribute 10 percent of your paycheck to your 401K, you’ll contribute $100. This is way more than you would’ve contributed after taxes.
What’s the difference between a 401K and a Roth IRA?
IRA stands for individual retirement arrangement, and basically is a 401K that you open up yourself. These are run through various investment banks, and basically do the same thing as a 401K. IRA’s are pretty cool because of their tax structure, which makes you win out financially in the end. They’re also awesome if you work at a place that can’t set you up with a 401K yet, or if you’re doing freelance or independent contract work.
So how do these things work, exactly?
Basically, when you’re contributing to a retirement fund, you’re investing your money through different stocks, bonds, and mutual funds. To put it very simplistically, it works the same for 401Ks and IRAs.
Don’t freak out if you don’t know anything about the stock market to make your own investments — we don’t either. When you set up a 401K or IRA, you’re entrusting a bank to make those investments for you.
When you’re young and won’t be accessing your savings for a long while, these banks usually invest in riskier investments. This is because there is plenty of time to make back your money, and there’s a good chance of a bigger payoff. When your fund starts to mature, the bankers invest in safer options so they don’t lose all of your money right before you’re going to need it.
And what’s this about matching?
When your employer sets up your 401K for you, there’s a chance they’re going to match your contributions up to a certain amount. Some really awesome companies will even match you up to 10 percent, which is usually the max amount you can contribute to your fund.
When your employer will match your contributions, we suggest contributing at least that amount to get the maximum payoff. For example, if your employer matches up to 4 percent, we suggest contributing at least 4 percent so you have a total of at least 8 percent contributions. It’s like free money, and we can’t say no to that.