There are many reasons people struggle with saving money. Many factors that we are sometimes are unaware of. In this article we will discuss some of these reasons. 11 reasons you are struggling to save money 1.Cost of living It would be an injustice to talk about saving money without acknowledging the cost of living. The inflation rate keeps rising which means prices are hiking while our income remains the same. High costs of living, such as housing, healthcare, and education, leave little room for saving after meeting essential needs. 2. You don't Budget (or stick to it) A budget is to your finances what water is to your body. You might survive a day or two without it but in a long term you will feel the effects. Without a clear budget, it's challenging to track income, expenses, and savings. Overspending becomes common, making it difficult to save 3. You live beyond your means Spending more than you earn will leave you with nothing to save. Spending more than w...
We are always encouraged to plan for the future. Have a retirement plan. But more often than not, people rarely ever explain what a retirement plan is. How to go about it and what options you have. In this issue, we will dive deep into the good, the bad, and the ugly about retirement plans. We will mainly focus on the most common one, 401(k).
What is a 401(k)?
A 401k is an employer-sponsored retirement plan. It is named after section 401(k) of the U.S Internal Revenue Code. The employee agrees to contribute a certain percentage of their salary to an investment account for retirement. Employers may match some or all of the amount.
This is a great investment vehicle for ordinary folks who work a 9-5. It is designed to encourage the working class to save and prepare for their retirement.
There are primarily two types of IRA; the traditional 401(K) and ROTH 401(k). The main difference is that the traditional 401(k) is made pre-tax and therefore reduces the taxable income and the withdrawals are taxed. Roth is made on after-tax income and the withdrawals are tax-free.
Most countries have a retirement fund plan. If you are not in the U.S, check with your company. In South Africa, we have a Pension fund. In the UK, they have what is commonly known as Contributory Pension Schemes and a Provident Fund in India. Enquire from your employer about yours.
How does a 401k work?
As mentioned, 401k is employer-sponsored therefore the employer is responsible for deciding who is eligible for the plan, how much the employer will contribute, and ensuring all laws and regulations are observed. The employer also has the responsibility of choosing the investment plans, usually mutual funds.
You (the employee) have the onus of deciding to participate in 401k and the contribution you will make. The employer can match part or all the employee’s contributions. For example, the employer can contribute 50 cents for every dollar contributed by the employee or a dollar for a dollar.
Contributions
401(K) contribution is deducted from the employee’s salary and invested in a retirement plan. Although it is not common, you can split your contributions between a traditional 401(k) and Roth 401(k). You need to stay within the provided limits. In 2021, the limit is $19,500 per year for workers under age 50 and $26,000 for those aged 50 and above. In 2022, the limit is $20,500 per year for workers under age 50 and $26,500 for those aged 50 and above. Consult with your HR department or tax advisor for a more detailed guide.
4 Benefits of a 401k
Tax Advantage
Traditional 401(k) is deducted pre-tax which will lower your taxable income and reduce payable tax. It might even put you in a lower tax bracket. Your contributions will then be tax-deferred and you will only pay tax when you withdraw the funds. This leads to the next benefit.
Might pay a lower tax rate
Your contributions may fall in the lower tax bracket than you would have otherwise been in and therefore reduce your tax payable.
You can take it with you
You can always take(move) your retirement when you change employment therefore you will not lose your funds when you change a job.
You can start now
Like any other investment, there is no better time to start contributing to your 401k than now. You will yield higher interest income if you invest early. It is imperative that you start contributing to your retirement fund as early as possible.
The 401k drawbacks
You can’t access it whenever you wish
The IRS discourages the withdrawal of retirement plans until you are 59.5 years old. You will face an early withdrawal penalty and income tax should you wish to withdraw it earlier. There are exceptions such as paying a substantial medical bill or disability.
Fees
There are a lot of fees incurred by retirement plans such as investment fees, administration fees, and service fees. These fees can take a huge chunk of your retirement. As much as 2% if you are employed by a small company. Small companies have fewer participants and even fewer asset distribution leading to higher administration fees.
Inflation
Since a retirement fund is in monetary form, it is largely affected by inflation. You need to take that into consideration when choosing your plan.
Three 401(k) mistakes to avoid
You can read as many articles as you like. Watch thousands of youtube videos and still have a few mishaps with your retirement find. I have listed some of the most common financial mistakes you need to avoid when choosing a retirement plan. Be sure to consult with your financial advisor.
Withdrawing when changing jobs
Not paying attention to interests
Not knowing retirement costs
Not consulting a financial advisor
Not taking advantage of the employer’s match
Bottom Line
There is a lot you need to consider when choosing a retirement plan. Consult your financial advisor and take advantage of compound interest. Always choose an option that works best for you. Financial security comes from considering your own needs and making yourself a priority. You need to start planning your future now.