Financial advice for a very fortunate 18 year old with a 401k?
October 4, 2014 9:47 AM
There isn't any matching, but my employer does contribute a flat amount. How much of my paycheck should I contribute to this 401k? How should I operate the 401k, and what kinds of investments should I make? How much should I save or invest seperately, in other accounts? Are there any other actions I should be taking, financial or otherwise?
I live in Michigan. I graduated from high school in June, and managed to get an assembly line job at the plant my parents have worked at my whole life. The job is full time, pays about $15.00 an hour with plenty of overtime equating to about 50 hours a week. I get paid every week and I get a $1.00 raise every year I work there. After a sort of probationary period I'll also be part of the UAW, and there are significant opportunities for jobs in skilled trades once I'm there for a few years. I also get benefits effective immediately, including health insurance I don't need yet (Dad's plan) and a 401k. The company will contribute $2.00 to this 401k for every hour I work, and I can contribute up to 50% of my paycheck. That might actually be feasible for me; right now I'm living at home and don't have many expenses other than things like phone bills, car insurance and gas costing me something like $250 a month. I'm also taking community college classes, but I'm not sure if I'll have the time to (or even want to) study what I wanted before I got this job. I suppose that's a different problem, though.
I live in Michigan. I graduated from high school in June, and managed to get an assembly line job at the plant my parents have worked at my whole life. The job is full time, pays about $15.00 an hour with plenty of overtime equating to about 50 hours a week. I get paid every week and I get a $1.00 raise every year I work there. After a sort of probationary period I'll also be part of the UAW, and there are significant opportunities for jobs in skilled trades once I'm there for a few years. I also get benefits effective immediately, including health insurance I don't need yet (Dad's plan) and a 401k. The company will contribute $2.00 to this 401k for every hour I work, and I can contribute up to 50% of my paycheck. That might actually be feasible for me; right now I'm living at home and don't have many expenses other than things like phone bills, car insurance and gas costing me something like $250 a month. I'm also taking community college classes, but I'm not sure if I'll have the time to (or even want to) study what I wanted before I got this job. I suppose that's a different problem, though.
If you can afford to put in the max, I think you should do that. You're right that you're very fortunate, because having the opportunity to put money in now means it has that much more time to compound - every dollar you put in now will generate a lot more money to you in retirement than a dollar you put in when you're thirty, so you should totally take advantage of that good fortune.
I would say the exception is if the skilled trade you'd want to pursue after your union membership comes through would have significant training costs to you or you think you would likely rather go on to college, you should probably set some money to pay for that too, even if it means not maxing out your retirement investments.
So far as that dilemma around further education or training goes, I would say, if you can learn or apprentice into some kind of trade through the UAW that would get you some skills in computer-aided manufacture, that's something to consider strongly. I think factory line jobs will have a much more tenuous future than ones that require skills in managing production automation.
posted by strangely stunted trees at 10:29 AM on October 4, 2014
I would say the exception is if the skilled trade you'd want to pursue after your union membership comes through would have significant training costs to you or you think you would likely rather go on to college, you should probably set some money to pay for that too, even if it means not maxing out your retirement investments.
So far as that dilemma around further education or training goes, I would say, if you can learn or apprentice into some kind of trade through the UAW that would get you some skills in computer-aided manufacture, that's something to consider strongly. I think factory line jobs will have a much more tenuous future than ones that require skills in managing production automation.
posted by strangely stunted trees at 10:29 AM on October 4, 2014
Do you get to choose what investments inside the 401(k) you're invested in? Some 401(k)s have that and some don't. (Is that part of your question? I can't tell.) If you do:
If that part is overwhelming, you can pay a fee-only financial planner for an hour of time to help you out with it the first time. Once you see how they do it, you can do a pretty decent job of it yourself, with the help of morningstar.com. I think it's worth the money to have someone else figure out your allocation the first time, though.
Your company is legally required to have an education meeting to help you figure this stuff out for free, but in my experience, this isn't implemented as often or as well as it should be.
Another free option is to call the broker on your account. Your account should have one. They might try to blow you off but don't let them- they get paid for this.
posted by small_ruminant at 10:38 AM on October 4, 2014
If that part is overwhelming, you can pay a fee-only financial planner for an hour of time to help you out with it the first time. Once you see how they do it, you can do a pretty decent job of it yourself, with the help of morningstar.com. I think it's worth the money to have someone else figure out your allocation the first time, though.
Your company is legally required to have an education meeting to help you figure this stuff out for free, but in my experience, this isn't implemented as often or as well as it should be.
Another free option is to call the broker on your account. Your account should have one. They might try to blow you off but don't let them- they get paid for this.
posted by small_ruminant at 10:38 AM on October 4, 2014
It is great you are thinking of this and able to start saving so quickly.
One of the biggest benefits of a 401(k) is that the money contributed to it is not subject to income tax. However, at your income level, presumably your income taxes are not very high. I would suggest putting the maximum into a Roth IRA, which you will only be able to contribute to at lower income levels, and then put the remainder of your "retirement budget" into your 401(k).
While you should always maximize the "free money" your employer will contribute to your 401(k), it is not the best option for lower income people to favor it to exclusion of Roth IRAs.
posted by deanc at 10:48 AM on October 4, 2014
One of the biggest benefits of a 401(k) is that the money contributed to it is not subject to income tax. However, at your income level, presumably your income taxes are not very high. I would suggest putting the maximum into a Roth IRA, which you will only be able to contribute to at lower income levels, and then put the remainder of your "retirement budget" into your 401(k).
While you should always maximize the "free money" your employer will contribute to your 401(k), it is not the best option for lower income people to favor it to exclusion of Roth IRAs.
posted by deanc at 10:48 AM on October 4, 2014
That's a very good point, deanc.
posted by small_ruminant at 10:50 AM on October 4, 2014
posted by small_ruminant at 10:50 AM on October 4, 2014
If the company just makes the same size contribution no matter what you put in, figure out how much of your overall pay you want to contribute to retirement accounts (keeping in mind that compound interest will have a much greater effect on the contributions you make now than the ones you make later and you cost of living is likely as low as it will ever be right now), subtract the company's contribution, then max out your IRA and/or roth IRA contributions. If there is anything left that you want to contribute, use the 401k paycheck deduction for that.
It's likely that a roth IRA will be better for you right now than a traditional IRA since you income is low right now (compared to what it will be 10 years from now, or so I hope we can assume) but that is a little bit outside the scope of your question.
Keep in mind that the 401k/IRA/roth IRA distinction is just how the funds are treated tax wise, the only one that has material limits on how you can contribute and what you can invest in is the 401k (or roth 401k if you have the option I suppose). Since you can usually only contribute via paystub deduction and only invest in the funds allowed by the plan.
You can open a traditional IRA or roth IRA with any brokerage and use it to invest in just about any mutual fund, stock, money market fund, or ETF that you want. The only reason people are encouraged to put money into a 401k first is because they usually have to do that get a company contribution which, in the case of a one-for-one match is an automatic and instant 100% return on investment.
posted by VTX at 10:51 AM on October 4, 2014
It's likely that a roth IRA will be better for you right now than a traditional IRA since you income is low right now (compared to what it will be 10 years from now, or so I hope we can assume) but that is a little bit outside the scope of your question.
Keep in mind that the 401k/IRA/roth IRA distinction is just how the funds are treated tax wise, the only one that has material limits on how you can contribute and what you can invest in is the 401k (or roth 401k if you have the option I suppose). Since you can usually only contribute via paystub deduction and only invest in the funds allowed by the plan.
You can open a traditional IRA or roth IRA with any brokerage and use it to invest in just about any mutual fund, stock, money market fund, or ETF that you want. The only reason people are encouraged to put money into a 401k first is because they usually have to do that get a company contribution which, in the case of a one-for-one match is an automatic and instant 100% return on investment.
posted by VTX at 10:51 AM on October 4, 2014
Make a budget. Everything you dont need to spend: put the first 10k in savings just in case, then into an IRA (first Roth because of tax reasons and the 401k once the Roth is maxed out). Your expenses are probably low but you should still plan around them.
posted by lownote at 10:59 AM on October 4, 2014
posted by lownote at 10:59 AM on October 4, 2014
Compounding is your best friend. The more money you put in now, the less you'll have to contribute in later years to end up with the same nest egg.
posted by cecic at 11:08 AM on October 4, 2014
posted by cecic at 11:08 AM on October 4, 2014
Ignore everyone else here. Put no money into the 401k beyond what is necessary for the employer to contribute, which in your case is 0%.
The 401k was designed as a tax benefit for the rich, who might be able to withdraw the money in retirement at a lower effective tax rate than the one they had during their prime earning years. People often comment that a 401k is tax-free, but it is not - you do pay income tax on it when you withdraw. If you're not paying money in when you're in a high tax bracket and withdrawing when you're in a low tax bracket - something that won't happen to the majority of Americans - the 401k doesn't make a whole lot of sense.
People say that compound interest is your friend. That's true, as long as there's interest. Unless you contribute to a cash or money market plan that has a very small interest rate, there is a substantial chance of your plan losing money at various times in your life. People will tell you that your plan will regain its value, and that might be true, but think about the crashes of 2000/2001 and 2007/2008, when the market lost substantial value and 401k accounts were left holding the bag - compound interest doesn't help you when the market keeps tanking. In addition, don't forget that, for the vast majority of funds, the bankers are sucking up a percentage of the money you invest every year in 401k and fund administration fees.
You are also nearing the time in your life when you are just a few years away from big purchases that can bring on very substantial debt. You probably won't live at home forever, and the down payment on a home is very substantial. You will likely buy a car at some point, and a big down payment or cash purchase will help you there. You will likely start a marriage and have a kid. You may need additional funds or have to help your parents if there are health issues with you or your family. If you have money in the bank that you can withdraw for a down payment or an emergency, it can will save you hundreds of thousands of dollars in debt or a bankruptcy down the road.
For a member of the middle class, having a limited debt load will help you for the next 49 years of your life. That 401k will only help you for the 20 or so years at the end of your life, if you get there. There will be a series of surprises in your 20s and early 30s that cause many people to buckle into debt, never to recover. It is truly insane that as a country, we recommend that the middle class lock all or most of their savings into an account with such high penalties to withdraw before they are near the end of their life.
Don't spend that money you make frivolously. By all means, save it for an emergency. Put it in a high interest checking account, or in I-bonds, or some other manner that puts that money slightly out of reach and with an OK interest rate but limited penalties if you need to get at it.
By all means, buy into the virtues of saving, but not the 401k. The 401k was not designed for you. The 401k was not designed for the majority of America. It is, quite literally, a tool used by the government for you to lock your money up in capital markets at a time you need it the most. You can save and invest without it, and you can also use the money you make from those investments to fund life changes you'll be going through for decades before a 401k will benefit you.
If you do that, maybe once you have a high income, are in a high tax bracket and have savings in the bank, the time will come where you should buy into a 401k. I wish you luck.
posted by I EAT TAPAS at 11:41 AM on October 4, 2014
The 401k was designed as a tax benefit for the rich, who might be able to withdraw the money in retirement at a lower effective tax rate than the one they had during their prime earning years. People often comment that a 401k is tax-free, but it is not - you do pay income tax on it when you withdraw. If you're not paying money in when you're in a high tax bracket and withdrawing when you're in a low tax bracket - something that won't happen to the majority of Americans - the 401k doesn't make a whole lot of sense.
People say that compound interest is your friend. That's true, as long as there's interest. Unless you contribute to a cash or money market plan that has a very small interest rate, there is a substantial chance of your plan losing money at various times in your life. People will tell you that your plan will regain its value, and that might be true, but think about the crashes of 2000/2001 and 2007/2008, when the market lost substantial value and 401k accounts were left holding the bag - compound interest doesn't help you when the market keeps tanking. In addition, don't forget that, for the vast majority of funds, the bankers are sucking up a percentage of the money you invest every year in 401k and fund administration fees.
You are also nearing the time in your life when you are just a few years away from big purchases that can bring on very substantial debt. You probably won't live at home forever, and the down payment on a home is very substantial. You will likely buy a car at some point, and a big down payment or cash purchase will help you there. You will likely start a marriage and have a kid. You may need additional funds or have to help your parents if there are health issues with you or your family. If you have money in the bank that you can withdraw for a down payment or an emergency, it can will save you hundreds of thousands of dollars in debt or a bankruptcy down the road.
For a member of the middle class, having a limited debt load will help you for the next 49 years of your life. That 401k will only help you for the 20 or so years at the end of your life, if you get there. There will be a series of surprises in your 20s and early 30s that cause many people to buckle into debt, never to recover. It is truly insane that as a country, we recommend that the middle class lock all or most of their savings into an account with such high penalties to withdraw before they are near the end of their life.
Don't spend that money you make frivolously. By all means, save it for an emergency. Put it in a high interest checking account, or in I-bonds, or some other manner that puts that money slightly out of reach and with an OK interest rate but limited penalties if you need to get at it.
By all means, buy into the virtues of saving, but not the 401k. The 401k was not designed for you. The 401k was not designed for the majority of America. It is, quite literally, a tool used by the government for you to lock your money up in capital markets at a time you need it the most. You can save and invest without it, and you can also use the money you make from those investments to fund life changes you'll be going through for decades before a 401k will benefit you.
If you do that, maybe once you have a high income, are in a high tax bracket and have savings in the bank, the time will come where you should buy into a 401k. I wish you luck.
posted by I EAT TAPAS at 11:41 AM on October 4, 2014
You are 18 and it's not a matched 401k; therefore you should contribute nothing. Let the employer put in the $2 per hour and add nothing to that.
For all intents and purposes, you can't access the money you put in there until you retire. It is lost to you for the next 45 years. However, you are very young and you are going to need cash for shit. I know this job seems awesome (and it is awesome) but it is also lucky. The number of jobs you can get grossing 40K a year with a high school diploma is very, very small. The security of most blue collar union jobs is very, very tenuous. And a 40K standard of living is amazeballs at 20; it's a struggle at 30. At some point this is very likely to come to a screeching halt, though circumstance or choice.
I think you are much better off saving. If you can save 50% of your pay check, pay some of that amount to your parents for rent and bills and save the rest for tuition or for whatever your Phase II plan may be. But you are going to need a Phase II plan, and you have the chance to plan for funding that now.
posted by DarlingBri at 12:17 PM on October 4, 2014
For all intents and purposes, you can't access the money you put in there until you retire. It is lost to you for the next 45 years. However, you are very young and you are going to need cash for shit. I know this job seems awesome (and it is awesome) but it is also lucky. The number of jobs you can get grossing 40K a year with a high school diploma is very, very small. The security of most blue collar union jobs is very, very tenuous. And a 40K standard of living is amazeballs at 20; it's a struggle at 30. At some point this is very likely to come to a screeching halt, though circumstance or choice.
I think you are much better off saving. If you can save 50% of your pay check, pay some of that amount to your parents for rent and bills and save the rest for tuition or for whatever your Phase II plan may be. But you are going to need a Phase II plan, and you have the chance to plan for funding that now.
posted by DarlingBri at 12:17 PM on October 4, 2014
DarlingBri: "You are 18 and it's not a matched 401k; therefore you should contribute nothing. Let the employer put in the $2 per hour and add nothing to that."
This, I hope you understand OP, is an extreme position. And that $2 per hour is still around $4,000 annually for typical full time employees. You are in a position to save presently, but many things are difficult to plan for. Should you save up to buy your own house? A bachelors degree? A safe, dependable car? Children's education? Retirement? Hard to say, at age 18 life is full of possibility. But of all the things on that list, retirement is the one thing you can't borrow for.
Moreover, there's some serious tax implications. If you make $40,000 and save 50% in a qualified pre-tax retirement account, you would probably meet the AGI requirement of the Saver's Tax Credit (but may be ineligible as a student). On the other hand, if you open a Roth IRA, there's some good options down the line (5 years) to use contributions as an extra emergency savings buffer. If you're by chance considering transferring to a 4 year degree school after CC, a 529 plan might not be a bad thing either. You may also want to consider budgeting for paying some rent to your parents, as a sign of thankfulness, maturation, and preparation for moving out on your own.
You probably want to think about this like a portfolio of possibilities. Based on what you've told us, retirement is the safe default goal, and your strategy might be to fund an emergency savings acct first, then fully fund a Roth IRA, and put whatever's left in the 401k. Read a lot about your 401k (are the expenses high? is there a borrowing provision, and if so, what are the terms, and how does that work if you quit / are laid off?), and look into Roth IRAs. Because this advice varies with the strength of the investments made available to you in your 401k vs Roth IRA. A motivated large employer can negotiate mutual fund expenses for their 401k lower than you can lower Roth IRA expenses by shopping around!
posted by pwnguin at 3:34 PM on October 4, 2014
This, I hope you understand OP, is an extreme position. And that $2 per hour is still around $4,000 annually for typical full time employees. You are in a position to save presently, but many things are difficult to plan for. Should you save up to buy your own house? A bachelors degree? A safe, dependable car? Children's education? Retirement? Hard to say, at age 18 life is full of possibility. But of all the things on that list, retirement is the one thing you can't borrow for.
Moreover, there's some serious tax implications. If you make $40,000 and save 50% in a qualified pre-tax retirement account, you would probably meet the AGI requirement of the Saver's Tax Credit (but may be ineligible as a student). On the other hand, if you open a Roth IRA, there's some good options down the line (5 years) to use contributions as an extra emergency savings buffer. If you're by chance considering transferring to a 4 year degree school after CC, a 529 plan might not be a bad thing either. You may also want to consider budgeting for paying some rent to your parents, as a sign of thankfulness, maturation, and preparation for moving out on your own.
You probably want to think about this like a portfolio of possibilities. Based on what you've told us, retirement is the safe default goal, and your strategy might be to fund an emergency savings acct first, then fully fund a Roth IRA, and put whatever's left in the 401k. Read a lot about your 401k (are the expenses high? is there a borrowing provision, and if so, what are the terms, and how does that work if you quit / are laid off?), and look into Roth IRAs. Because this advice varies with the strength of the investments made available to you in your 401k vs Roth IRA. A motivated large employer can negotiate mutual fund expenses for their 401k lower than you can lower Roth IRA expenses by shopping around!
posted by pwnguin at 3:34 PM on October 4, 2014
One thing to note about the Roth IRA is that, since you contribute after-tax money into it, you can take those contributions back out, penalty free, five years after you make the first contribution (starting from Jan 1. of tax year in which you made the contribution) so it usually makes for a good back-up emergency fund. The interest/gains get a 10% penalty AND you have pay taxes on them if you take them out before retirement (though there are some exceptions) but you can access the principle.
posted by VTX at 3:31 PM on October 9, 2014
posted by VTX at 3:31 PM on October 9, 2014
This thread is closed to new comments.
After that is done, see where you stand and adjust as needed. There is also benefit to having about 10K in liquid assets around as that generally covers 6 months living expenses for most. Good luck and you're on the right track.
posted by lpcxa0 at 9:54 AM on October 4, 2014