8 things you need to know when opening up a 401(k)
Opening up a 401(k) — the ultimate act of adulting — is often outside most people's area of expertise and can appear confusing and daunting.
To make it less stressful, we asked financial experts Patrick Murphy, president of John Hancock Retirement Plan Services, and Meghan Murphy, a director at Fidelity Investments, for their top things to know when starting a 401(k).
Here's what they had to say:
1. Just start investing — and early
First, determine if your employer offers a 401(k). If yes, then sign up and start putting away a percentage of your paycheck. Your 401(k) contributions are tax-free since they are made with pre-tax dollars and you only pay taxes when you begin to withdraw the money during retirement.
Start contributing as soon as you can. Meghan Murphy said the difference between starting to contribute to your 401(k) at 25 vs. 35 years old can be hundreds of thousands of dollars.
Patrick Murphy said don't overthink it, just start saving, even if it's a little. He said once people see the account grow, they become more engaged. Don't wait, he said, because "that compounding interest over time is phenomenal."
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2. Take advantage of the company match. All of it.
If you don't, Patrick Murphy said, you're giving up free money.
About the company match. Companies often will contribute up to a certain percentage of your contribution to your 401(k). It's free money so be sure to contribute up to the maximum of your company's 401(k) match.
"People should maximize as much as possible," Patrick Murphy said. "Otherwise you're just leaving money on the table."
3. Save about 15% of your income
Meghan Murphy recommends people put away about 15% of their income toward retirement, that includes a company match. By the time you are 30, she said, you should have a year's worth of your salary saved.
Thinking long-term, Patrick Murphy said you should plan to have enough in your 401(k) to have about 70 to 80% of your income in retirement. For instance, if you make $50,000 a year, you'll need about $40,000 a year in retirement. That, of course, depends on what you want to do in your golden years. Dream of traveling or want to leave some money to your heirs? Then you may need to adjust.
Meghan also suggests people take advantage of automatic annual increases. Many employers offer the ability to automatically increase the percentage you save after a certain period of time.
4. Get your financial life in order and avoid tapping into your 401(k)
Finances can be among the biggest stresses in one's life, Patrick Murphy says. It can be exacerbated if one taps into their 401(k) early. Most financial advisers recommend not doing that since you will face a tax penalty and will be diverting money from your retirement and losing investment return.
Murphy suggests learning the basics of budgeting. Avoid the need for tapping into your 401(k) by establishing an emergency fund of three to six month of expenses in the case of a job loss, illness or an unexpected expense.
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5. If you change jobs, whatever you do, don't cash out your 401k
Meghan Murphy said you'll have to play taxes plus a withdrawal penalty.
You have several options available, including leaving you money in your previous employer's plan, rolling over your 401(k) to your new employers's plan or moving it into an IRA (Individual Retirement Account.
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6. Find out what to invest in and ask questions
Meghan Murphy said you need to decide what route you want to go. The do-it-yourself path, which involves studying investment performance trends, or farming it out to a professional.
Most plans, she said, offer professional help in figuring out what funds to invest in as well as other professional help. She stresses investors should ask questions if they have them. There are people to help.
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7. Check back and accept things may change
"Retirement is really a journey," Patrick Murphy said, "not simply a destination with an endpoint."
Murphy's point is the end of your working life may look different than you see it now. People are living longer, not everyone retires at 65. People, he said, should be thinking about how their income needs may ebb and flow in retirement.
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8. Talk with a financial advisor.
Patrick Murphy said people who seek an advisor's help are generally better prepared for retirement and have lower anxiety.
Follow Sean Rossman on Twitter: @SeanRossman