What is a 401k? (For Beginners)

Updated : Nov 16, 2019 in Articles

What is a 401k? (For Beginners)


Hey guys, it’s Suzanne with Arvabelle. In this video we’re going to talk about 401(k)s. I would always hear people talking about 401(k)s and I was like, what is that? What what does it do? I don’t understand. How do you adult?They didn’t teach us this in school. So we’ll just go over what a 401k is and some of the pros and cons of these accounts and how you can take advantage of them to start putting your money away and saving for your future when you are an old little person that needs some money If you’re new to the channel, be sure to subscribe. We talk about money, mindful living, and things that you didn’t learn in school Just to give you a general understanding 401ks are types of retirement accounts So if your employer is giving you a 401k you can think about it like they’re giving you a basket and you can put your money and different investments in that basket and grow the things inside of it through compound interest If you don’t know what compound interest is just explaining it super quickly in the next like five seconds It’s basically instead of letting your money sit in a bank account hopefully by investing it, that money will make you extra money. And that extra money will make you even more money on top of that and so on and so on. The general idea of a traditional 401k is that you’re putting in money now and you’re putting off paying taxes on it until you take the money back out when you’re 59 1/2 or older You can choose to put a percentage of your income into this account Whatever amount you choose will be deducted from your total taxable income So for example If you make $100,000 and you contribute 5% or $5,000 to your 401k your total taxable Income will be $95,000 You won’t pay taxes on the money that you put into your 401k until you take it back out. And when you do take it back out, it will be taxed as regular income I do want to bring up the importance of having an emergency savings fund. When you put money into these retirement accounts, the money isn’t as accessible There will be a fee to get it out before the required age. If you try to withdraw money from your 401k account before you’re 59 1/2 they will hit you with a 10% fee and you’ll see have to pay taxes on top of that So if anything happens before you retire and probably something will happen your car will break down or you’ll get sick or something – something in your life will happen So it’s good to have an emergency fund so that you’re not hit with unnecessary fees from trying to withdraw from retirement accounts So, like I said, you can withdraw money from your 401k Once you hit 59 1/2 and you won’t be hit with that 10% fee. And once you hit age 70 1/2 you have to start taking mandatory distributions which just means that you have to start taking money out of your 401k. The advantage of a 401k account is that usually your employer will match the amount of money that you put into the account up to a certain percentage of your income So for one-to-one matching for every $1 that you contribute, they’ll contribute $1. For every $1,000 you contribute, they’ll contribute $1,000 They’ll usually do this up to a certain limit. So that may be up to like 5% or 10% of your income But not every company will match one-to-one. Some will say for every $2 you put in we’ll put in $1. For every $4 you put in, we’ll put it in $1 It really just varies. In most cases people like to try to max out their contribution So meeting that maximum point where their employer will stop matching So if your employer is offering to match up to 10%, and you’re only putting in 9% You’re leaving an extra 1% on the table Like that’s just free money that you’re leaving Take it And of course if you want to go over the amount that they match you can. It’s just when it hits that certain percentage they’ll stop contributing money to your account. You can contribute up to the limit that the government sets So I think in 2019, it’s $19,000. And that number is higher if you’re 50, and it changes occasionally So it’s just something to check. Now Roth 401k’s are still relatively new, but they are becoming a more popular option that employers are offering So basically, it’s the same as a traditional 401k, but it has some of the benefits of a Roth IRA which I will talk about in Thursday’s video. So subscribe When you contribute to a traditional 401k, which we just talked about, your contributions are pre-tax So like we said you put in the money And you won’t be taxed on it until you take it back out But with a Roth 401k your money goes in after taxes So that means that you pay taxes now, but when you take the money back out Whatever you put in and whatever amount your money grew to, you get to keep all of it. Just for comparison let’s say that by the time you retire, you have $1,000,000 in your account. If that’s in a Roth 401k that money’s yours, you get to keep it, you can go party in Florida or…I don’t know – wherever old people go If the $1,000,000 is in a traditional 401k, you will still need to pay taxes on it So I’m just throwing out random numbers but if you have a 20% tax that means that of the 1 million dollars, you’ll have to give $200,000 of it back to taxes There are several advantages to a Roth 401k if your employer offers it. In addition to not paying tax on what you withdraw there’s really not a way to predict with certainty what tax bracket you’ll be in when you retire or how tax percentages will change in the future. With a Roth 401k those tax changes won’t affect you since you already paid taxes on the money before you put it in There are a few more things to know about Sometimes employers will offer profit sharing in their 401ks instead of matching. And what that means is that instead of matching a dollar amount that you put in, they’ll put in a certain percentage of the company’s profits In your offer letter, or in the wonderful 50 page packet that you’ll get, you may also see something about vesting. That’s vesting, not investing. Vesting means that the company’s contributions to your account are basically locked away for a certain amount of time So if they tell you that there’s a 4 year period before you’re fully vested That just means that you can’t take out the full amount that the company has contributed to your account until after 4 years have passed So if you quit your job, the money that you invested from your paycheck – that’s yours But you do need to find out what your employers vesting policy is. So still using the 4 year example, with some companies if you quit before the 4 years You won’t get any of the money that they contributed to your account Or they may have a plan that increases the amount that you are vested in your plan by a certain percentage each year We’ll use 25% as an example. So if each year it increases by 25% it’ll take four years for you to be fully vested, and for you to get the full amount that your company contributed. If you leave your job after two years you’ll be only 50% vested which means that you’ll only get to keep 50% of what your company put into your 401k Most employers will offer plans that are mutual funds made up of stocks bonds, etc You do want to look at the package that your company is offering and watch out for excessively high management fees. If your account isn’t growing that much, but the management fees are super high you probably won’t really be making much money Also if you’re moving between companies you don’t necessarily have to withdraw the money and pay that 10% penalty There are usually ways that you can rollover your 401k to a new company so that’s something to ask your employer about, ask a financial adviser about, and see if that’s something that you need to do or that you’re interested in doing. Ask lots of questions do your research talk to your employer, if you have a financial advisor, find out about your specific account, their requirements and regulations, and do your research so that you can decide which account aligns with your lifestyle and your financial goals. If you found this video helpful be sure to give it a like, subscribe, visit our blog Arvabelle.com, follow us on Instagram And I will see you on Thursday to talk about Roth IRAs

7 Comments

  • Love seeing more people put out info on 401K's its sad that the educational system can't teach us about 401K's but i'm inspired by all those in the youtube community who share their knowledge. Great quality video keep up the good work!

  • I didn’t even know that 401k’s were compound interest… Thank god I have my younger cousin to teach me how to adult 😂😅

  • I wanted to ask you a question: do you think 401ks are something you should be funding while trying to pay off student loan debt?

  • I was sooo ignorant to 401Ks before I opened mine!!! Once again you covered all bases spot on! They definitely all vary and with my company there is a 14.9% fee for early withdrawal 😔

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