401K for Dummies – A Beginners Guide to 401K Plans

Ever feel like you’re not quite using your 401k properly or maximizing its effectiveness, or maybe there are things that you don’t quite understand? This video is going to get to the bottom of it for you.

Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, host of the Retirement Income Show and CERTIFIED FINANCIAL PLANNER™ Professional (CFP®).

Okay, so first things first, let’s talk about free money, and this is the match that your employer may offer when you make a contribution to your 401k. So the language may go something like this: 100% match on the first 3% and a 50% match on the next 2%.

So first, you need to be making contributions to your own account before your employer will match what you put in. But if your salary is 100,000, and you contribute $10,000, the first 3% is $3,000, they’re going to match that give you $3,000 in your account.

The next 2%, they’re going to match at 50%. So what this language means is if you put in $10,000, and your salary is 100, you’re going to get $4,000 in free money. So you may want to go through and understand that a bit more closely, but that’s how that works, that’s what that language means.

Now, for 2020, the max contribution you can put into your 401k, and again, we encourage you to save as much as you can for retirement, if you’re less than 50 years old, $19,500, if you’re 50 years old or greater, 26,000 is the maximum that you can put into your 401k.

Now, once you’ve decided how much you’re going to put in there, and you understand the match you’re going to receive, you have to decide if you’re going to put that into the pretax part of your 401k or the Roth part of your 401k.

Now most of you will have this option available to you, some of you won’t, to put it into the Roth 401K. If you don’t, talk to HR, tell them you want this in your 401K, it is in your best interest and you have a right to advocate for things that are in your best interest when it comes to retirement savings. So what this means is if you put it into the pretax portion, you will receive a current tax deduction, you will not pay taxes on that income as it goes into your 401k, it will grow tax deferred and then in retirement, when you take it out, you will owe income taxes on everything that you take out of that account.

Or, you could put it into the Roth part, you will get no tax deduction for putting money into that 401k, into the Roth, you will pay taxes on that income today, but it will grow tax free forever and when you get to retirement, all of that money plus all of the interest will come out tax free.
So if you think taxes might be higher in the future, it’s a wise idea to consider putting some money, if not all of your contribution depending on your situation, into a Roth, the Roth part of your 401k.

Once you’ve figured out where you’re going to put it to, now you have to figure out your equity and bond allocation. So fancy words that mean what are you going to invest in? So you have to choose between the current funds inside your 401k and then future contribution, so money you will put it in the future, how you want those future contributions to be invested and how do you want your current funds to be invested?

One thing people have done over the past is create these target date funds. Target date funds are essentially funds that are used to target when you expect to retire. The 2030 fund, 2040 fund, 2050 fund. As you go out in time, you have more exposure to stocks. That means you’re younger, you should be invested more in stocks because over the long term they return, or are expected to return much, much higher than bonds. The closer you are to retirement, theoretically, the closer you should choose a date for your target funds, depending on the amount of risk you want to take in your account.

Now, should you take a 401k loan? If you take a 401 k loan, there’s a few things you need to know. First, the maximum amount that you can take as a 401k loan is 50% of your account balance or $50,000, whichever is less. There must be a loan agreement, there must be an interest rate that you pay, a loan must be repaid within the five year term and payroll deferrals or salary deferral, so it comes out of your paycheck is how you pay that 401k loan back.

Now if you can absolutely avoid it, do not take a 401k loan, these are not good for your retirement. But if you do need to, there are things in place that can allow you to do this. And if you need a hardship withdrawal, this means you’re younger than 59 and a half and you need to take money out of that account, you can take a hardship withdrawal, although this is very, very ill advised because you’ll have to pay income taxes and a 10% penalty on the withdrawal that you make. Your employer does not have to allow this, but if they do, the IRS allows it at a very, very steep cost, but for certain medical expenses, home Buying expenses for a principal residence, 12 months’ worth of tuition and fees, to prevent being foreclosed, and if you have casualty losses from a hurricane, fire or something like that.

So this is good information. You want to share this stuff with your friends, with your family members, so they understand how to make 401k withdrawals, what the rules are, and understand that if we are saving money in our 401k, the sole purpose, the sole purpose of a 401k is to provide a retirement income. That’s it. That’s exactly what the 401k is designed to do. So hit the like button, subscribe to the channel and I look forward to keeping you more connected to your money.