Hi, Professor Erkis. The company where I will be working full time next year sent me forms to fill out, including 401(k) retirement plan forms. The paperwork said they will match 50% of the first 6% I contribute. Should I contribute to a retirement plan at my first job? — Liza P. ’20, economics major
Erkis: First of all, congrats on the job. That’s great. My general answer is yes, start contributing now. It’s never too early to start saving for retirement. Your company is providing a very nice incentive for you to participate by providing a company match. For that reason, you should put in at least 6% of your annual salary to obtain the largest dollar match.
A 401(k) is a type of tax-advantaged retirement account where your employer puts part of your paycheck into a special account for you before it is taxed by the federal government. Not only do you not pay federal tax on the money put into a 401(k), but you also do not pay any tax on the earnings within the 401(k). You pay the income tax later when you take the money out of the account. This tax deferral is an important benefit because it allows more of your money to grow each year.
Only put money into a 401(k) that you can leave there for many years, because there are significant penalties if the money is taken out of the account before you reach the age of 59 1⁄2. Therefore, since you are just starting out, it is OK to wait a few months to start contributing if you feel you need the money now that you would put into the 401(k). I usually recommend a person has about six months of living expenses in cash before putting money away for retirement. But, please don’t forget to sign up for the 401(k) since the benefits are so good for contributing!
You want to put money in now (or soon), because time is your friend when saving for retirement. Assuming an average return of 7% for 45 years (a reasonable assumption for the stock market return from now until you retire), each $1 put into your account today will be equal to $21 when you retire (before tax). Yes, you read that right; 21 times bigger due to the power of compound interest. Congratulations again on the job!
Lubomirski: It seems really odd to be thinking about retirement when you’ve just started your first job out of college, so some might figure a 401(k) makes no sense. But, I can see the value of the tax deferral and the company match. It is clear that the sooner you start, the better. However, I think I will take a few months to figure out how much of my salary I can afford to contribute and not rush into it immediately. I want to figure out how much of my salary I really need for expenses, backup money, etc. before depositing some of my salary into the 401(k) plan. I definitely will contribute though and will put a reminder in my calendar a few months out so I don’t forget to sign up.
Nothing stated in this column should be considered investment advice or an offering of securities. Stock investing has risk and you should do your own research before investing.
