Congrats, Class of 2016! With one major milestone behind you, you're about to embark on another - starting your first job. For many of you, this also means you'll be saving in a 401(k) for the first time. At your age, retirement might seem like a lifetime away, but saving early and for the entire length of your career can pay big dividends down the road.
Since this is likely new territory for you, I've outlined several 401(k) basics that are good to know as you get started on the path to saving for retirement:
1) Enrollment eligibility may vary, but start as soon as you can. Depending on where you work, you may be able to sign up for your 401(k) on day one. Other companies may require you to have six months or a year of work under your belt before you can participate. Once you've figured out your company's requirements, create a reminder on your calendar and enroll as soon as you're eligible. Thanks to the power of potential compounding, the earlier you start saving, the more money you can have in your account in retirement.
If you are at a firm that requires you to wait before you can contribute to a retirement plan, use that time to get into the habit of saving money from each paycheck. For example, if you plan to allocate 6 percent of your salary to your 401(k) once you're able, then take that 6 percent and put it towards an emergency fund, paying down credit card debt or paying down high interest loans in the meantime. That way, when it comes time to start putting money towards your retirement, your other financial priorities will be that much more manageable, and you'll have gotten into the discipline of saving regularly.
2) You might also be automatically enrolled in the company 401(k) plan. Sometimes employers will take actions on their employees' behalf with an eye towards their financial future. In a retirement planning context, this often means auto-enrollment, or the automatic withdrawal of 401(k) contributions from your paycheck as soon as you meet the eligibility requirements. Some companies will even auto-increase your contribution rates at certain milestones like when you get a raise or promotion, so you save more as you earn more.
3) Your employer may contribute to your 401(k) as well. One of the greatest advantages of saving in a 401(k) is that many companies offer some form of matching contribution. For example, it might be a match of 50 cents for every dollar you contribute, up to 6 percent of your salary. If your company plan does offer a match, you would be wise to contribute enough to take advantage of it in full.
I realize that right now it may be difficult to think about saving for retirement, let alone saving 6 or more percent of your salary, when you have so many competing financial obligations. In a recent survey, more than a third (37%) of Millennials said they can't set aside more money for retirement because they are still paying off student loans*, and that's understandable. But as I always say, contributing enough to get the full 401(k) match should be your number one financial priority, even before paying down credit card debt or loans. Why? Because the 401(k) employer match is like an automatic return on your investment that you can't get anywhere else.
4) Most 401(k) plans offer a range of investment options, potentially including some low-cost funds. A typical 401(k) menu will consist of a wide selection of funds across several asset classes, such as large-cap stocks, international stocks and bonds. A key factor in selecting which funds will make up your portfolio should be your investment risk tolerance, which usually corresponds with how many years you'll be in the workforce. For the most part, younger workers will allocate most of their portfolios to stocks, and over time, gradually move the balance towards more conservative bonds and other fixed income investments.
Your 401(k) plan may also include some low-cost investment options, like index mutual funds and exchange-traded funds. These kinds of funds typically have lower operating expenses, so investing in them can mean putting less of your savings towards management fees and putting more into your account.
5) You may have access to professional 401(k) advice. Saving in a 401(k) can be confusing for workers of all ages, but it may be especially daunting for first-time employees. The good news is that many 401(k) plans offer some form of managed account service or third-party, professional advice. If your plan offers such a resource, I'd highly encourage you to take advantage of it. In the aforementioned survey, 76% of Millennials claimed they would like help managing their 401(k), but only 22 percent said they are likely to seek out professional investment guidance. The best way to get help is to ask for it, so be proactive and find out if advice is available to you.
If your plan does not feature an advice component, another option to explore is a target-date fund. These funds adjust their stock/bond mix to be more aggressive when you are younger and more conservative when you near retirement. Target date funds are a popular offering in 401(k) plans. If you choose to invest in one, revisit your investment at least once a year to make sure it still fits with your needs. As a new grad, you might want to consider a fund with a target retirement date of 2055 or 2060.
6) Your 401(k) could influence your tax bill and can provide strategic tax planning opportunities. Since you're new to 401(k) planning, you'll want to understand how different types of 401(k)s will impact your tax strategy. For instance, traditional 401(k) plans can help lower your annual tax bill because you make your contributions with pre-tax dollars. A Roth 401(k), also offered by many companies, is funded with after-tax dollars, meaning the money you withdraw from your account in retirement is then tax-free after you meet certain requirements. The Roth 401(k) tends to appeal to younger workers, who anticipate retiring in a higher tax bracket than when they began their careers.
Unlike with your college exams, you can use this little cheat sheet as you start your new career and have important conversations with your HR department. You can also check out the many online resources that are available these days. Congratulations again, and best of luck as you start this new chapter!
*2015 401(k) Participant Survey conducted by Koski Research for Schwab Retirement Plan Services, Inc. Koski Research is not affiliated with Schwab Retirement Plan Services, Inc.
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