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- What's up guys, I'm George Campbell and today we're talking about America's most popular retirement account, the 401 . - A what? - 70% of Americans have one, but a lot of people don't understand exactly how they work. In fact, only 60% of Gen Z even knows what a 401 is. No cap, big yikes. - Period.
Period. That's no bueno, because your golden years literally depend on the investment choices you make today. So unless your retirement dreams include slinging Frappuccinos at 98 years old, you need to understand how your retirement plan works. And in today's video, I'll tell you the seven main things you should know about your 401k plan and how you can use it to build some serious wealth. But first, make sure you like this video, subscribe to the channel, and share this with all of your Gen Z friends who think a 401k is a really long race. Just
Just because that ends with K doesn't make it a race. No cap? On God. Okay, let's start with a simple definition. A 401k is a tax-advantaged retirement savings plan sponsored by an employer. And in case you're wondering, it's named for the 401k subsection of the tax code that governs how it works.
But you're not here for the boring legal stuff, so let's get to the seven main things everyone should know about their 401k plan. And if you really do want more of the boring stuff, check out my ASMR channel where I read the tax code in a relaxing voice. It's for a very specific audience that doesn't exist because no one's watching it. Provides that a profit sharing plan that includes a cash or deferred arrangement can meet the requirements of 401A, provided that the cash or deferred arrangement constitutes a qualified cash...
Okay, the first thing on the list is important to understand because it's the whole reason a 401k is a good place to put your money. And that is tax advantages. Now, different 401k options come with different tax advantages. With a traditional 401k, contributions are made with pre-tax dollars. That means the money goes into your retirement account before it gets taxed. So the money you put in and any earnings in the account from interest, dividends, and capital gains are all tax deferred.
That means you don't owe income tax on these funds until you withdraw money from the account in retirement. Another tax advantage to a traditional 401k is that your contributions can lower your taxable income for the year. So for example, if you make 70 grand a year and you put $10,000 into a traditional 401k, that would knock down your taxable income to 60,000. Which is a good thing because that's $10,000 of your hard-earned money that you get to keep out of Uncle Sam's grubby little fingers. Taxes! Taxes!
TAXIS! Now there's another type of retirement plan called a Roth 401k with slightly different tax advantages. In a Roth 401k, your contributions are made with after-tax dollars, which means you don't pay taxes on the growth or the money you take out when you retire. Now, there's a lot of debate as to which one is better, and it all comes down to this.
Do you want to pay taxes now with known factors like tax rates and income levels or later with unknowns like what your retirement income will be and if the tax rates and tax brackets will change? Now, I personally recommend the Roth 401k. That's what I have. And here's why. If I've got $2 million sitting in a Roth account, that's $2 million in tax-free net income that I can use to live my best life in retirement.
I don't want to have to limit my lifestyle in order to avoid being in a higher tax bracket in my golden years. Okay, the next thing everyone should know about their 401k is also very important because it's your ticket to free money. I'm talking about the employer match. Most companies with a 401k plan provide a match on employee contributions.
The average employer match is around 4.5%. But even if your match is less, that extra money can make a big difference in your nest egg over time. For example, if you make $50,000 and you contribute 15%, that's $7,500 a year.
But the first 4.5% is matched, which means your employer put in an extra $2,250 on top of that. That's a 100% return on that 4.5% contribution. That is free money. Take it. Quick side note here. Even if you choose the Roth 401k, most employer match money will go to the traditional side. So you will owe taxes on that match money in retirement. Don't freak out.
It's fine. - Panic mode engaged. - No, no, no, no, no, stop! Okay, the next thing everyone should know about their 401k is a little more complicated, and that is the vesting schedule. And despite what it sounds like, this is not a calendar showing how many days you plan to wear a vest. I have a separate calendar for that. - That's odd.
Very odd. But when it comes to your 401 , vesting refers to how much of the money your employer contributed belongs to you if you leave your job. Now obviously the money you contribute is all yours, but some employers have nitpicky guidelines about how much of their matching contribution you can take when you leave. So for example, if your company increases the amount you're vested in by 25% every year, leaving your job after only two years would mean you could only take 50% of those employer contributions with you.
But after four years of 25%, you get to keep 100% of the employer contribution because you're fully vested. Just like Han Solo, Aladdin, and the Target Lady. Although Aladdin's vest is so little, can we consider that a fully vested situation? He was showing a lot of six-pack. No one's mad about it, but for a guy who only ate bread, I'm shocked. Stereotype!
If you don't know if your company's 401k plan has a vesting schedule, check with your HR department and they can give you all the dirty deets. Plus, they love when people talk to them. They're really lonely. Hey, nobody cares.
Nobody cares. All right, the next thing you should know about your 401k is pretty straightforward but still very important, and that is withdrawal penalties. According to the IRS, you can't withdraw money out of your 401k before the age of 59 and a half without paying income taxes and a 10% early withdrawal penalty. So TLDR, do not take your money out early. I cannot stress this enough. Your 401k is an investment in your future, not a piggy bank for when you're in a financial bind.
Even if the fridge breaks or you have an unexpected podiatry bill or you find out it's going to cost 14 grand to sanitize, re-insulate, and seal your entire attic because squirrels have been making babies in there for a decade, do not use money from your 401k. That's what your emergency fund is for. The only time you should even consider taking money out of your retirement accounts early is to avoid bankruptcy or a foreclosure.
Otherwise, hands off to 401 . No touchy. Okay, the next thing on the list is a big deal because it can help you avoid paying a penalty and having some of your contributions double taxed, which is not good. You know what else isn't good? Data brokers selling your personal info online to strangers. And that's why I use Delete Me.
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All right, the next thing to know about your 401k is contribution limits. Always make sure you have the correct numbers for the current tax year because these numbers change more than Usher and the Super Bowl halftime show. Does taking off your shirt count as an extra wardrobe change? I'm not mad about it, just asking. Maybe you want to put your vest back on?
What are you, a cop? For 2024, the yearly contribution limit is $23,000. But if you're 50 or older, you get a little senior special and get to contribute an extra $7,500 through catch-up contributions. Not ketchup, catch-up. Educated people pronounce it catsup. Now, if you go over the contribution limit and put in too much money, you gotta let your employer know ASAP to get this resolved.
Because if you don't handle it before tax time, you'll have to take that money out, which means paying that 10% penalty for the early withdrawal we talked about. And those excess contributions will be double taxed because you'll pay taxes on them in the year you contributed and in the year you took them out. So pay attention to the contribution limits and make sure your automatic deductions don't put you over that number. Okay, the next thing you should know about your 401k is the fees.
According to an AARP study, 71% of people with 401ks didn't even know they were paying fees for those retirement accounts. But fees are part of nearly every 401k plan, so don't freak out. Now, these can range from a half a percent all the way up to 2%, depending on the size of your company's plan, the number of participants, and the plan provider. But the average is around 1%. And 1% might not seem like enough to shake a stick at, but when you consider how much that fee can eat into your retirement savings,
it might be worth some stick shaking. But here's the good news. If you're getting a company match on top of those contributions, the gain is just about always worth the fees. Okay, next thing everyone should know about their 401k just might be the most important thing. You really want to make sure you get this right. And it's this, when to start investing in one. And you may think I'm going to say ASAP, right now, the best time was yesterday. But nope, don't start investing until you're financially ready.
What does financially ready mean? It means you have no debt except your mortgage and you have an emergency fund with three to six months of expenses in it. And if you're currently investing, but you still have debt or you have no emergency fund, it's time to hit the pause button on all investing. And before you jump in the comments like,
George, that's crazy. I can't believe you're telling people to give up the free money. Calm down, bucko. Hear me out. Your income is your greatest wealth building tool. And when your income is tied up in debt payments, you're robbing yourself of a chance to build real wealth. Think of how much you could be investing if you had all of your income at your disposal. And if you start investing without an emergency fund in place, where do you think you're going to look for money when Steve from Critter Gitters tells you that it's going to be $14,000 to relocate the entire scurry of squirrels? Yeah.
That's right, your 401k. And it's gonna put a huge dent in that nest egg because it can be freaking expensive to get rid of squirrels when they can find their way back to your house even if you drop them off in a field 15 miles away. Smart little river rats they are.
Plus, if you take money out of your 401k early, you'll also get hit with those taxes and penalties we talked about. That's why it's so important to be financially ready before you start investing, so that you can be consistently investing in your future, even when bushy-tailed rodents start reproducing in your rafters.
And the other benefit of pausing investing is that it will light a fire under you to get out of debt and save for emergencies faster because you want to get back to investing and building wealth. And get this, when you do, you won't be investing up to the measly match. You'll be investing 15% of your income. That's the goal. Okay, the last thing everyone should know about their 401k can make a huge impact on how much money they have in retirement. And it's super important to get this right. And that is how much to invest.
Now, like I mentioned, I recommend investing 15% of your gross household income into retirement. And here's the five-word investing strategy to help you remember where to put it. Match beats Roth beats traditional. So,
So if your company offers a 401k match, contribute up to that amount and then move on to a Roth IRA, to the Roth options. Now, if you max out the Roth IRA and you still haven't hit 15%, go back to the traditional 401k until you've hit 15%. Now, quick caveat here. If you have a Roth 401k option with good funds and low fees, you can just go ahead and invest all 15% right into that account. Now, all of this is going to set you on a path to building serious wealth. I'm going to be rich.
So to put a bow on this, here's a fun little example. Let's say you make $50,000 a year and you invest 15% of that into a Roth 401k account starting from zero. Now, let's say you do this from age 27 to 62 and you never get a raise that entire time and you don't ever have an employer match. Well, looking at the average annual return of the stock market, let's say you get 10% on average.
Well, over that period of time, you would end up with $3 million tax-free to use in retirement. And guess how much of that was money you actually contributed? $262,000 out of 3 million. The other 91% of that account balance was compound growth. It was your money making you money. And all you had to do was consistently invest over a long period of time.
That is the coolest thing I've ever heard. So if you make 50 grand, you could have $3 million if you start at 27. And if you make more than that, you could have even more money. But you gotta start early, and it starts when you're debt-free with an emergency fund. That's what's gonna allow you to invest 15% instead of a measly 3, 4, or 5.
So if you're new to investing and you want to learn how to do it the smart way, check out this video where I give you an overview on how to get started. You can also check it out with the link below. And don't forget to subscribe to this channel, like this video, and share it with someone you know who loves squirrels and needs to know the truth. They're just rats with a master's degree in cuteness. Don't fall for it. Thanks for watching. We'll see you next time.
