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Starting a 401(k) Plan: What You Need to Know

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What You Need to Know About 401K PlansWe were about to ask, “Have you started a 401(k) plan yet?” And before we even finished typing that sentence, we heard you say, “Ha! Good one!” Yes, we know you have student loans, car payments, and a sizeable rent on that new apartment. You have a lot of must-pay bills and maybe you think a retirement savings account is something you can’t afford right now. But financial experts say you can’t afford not to.

If you’ve just graduated and your employer offers a 401(k) plan, you need to consider getting in on the savings action – pronto. Jobs with pensions are a rarity these days and if you’ve watched the news in the last few months (or ever), you know that Social Security is hardly a guarantee. You need to take your financial future into your own hands and open a 401(k).

Not sure how it all works? Our friends at Barnes & Noble College’s blog, the College Juice, are here to help with everything you need to know to get started with a 401(k).

What is a 401(k)?
Basically, it’s an employer-sponsored savings account for retirement. You can start using this money once you’re 59½ years old, or if you’re 55 and you’ve left your job. (And there are penalties for early withdrawals.) The sooner you start saving (like, now), the more your money can grow.

How much should I contribute?
As a general rule of thumb (by financial experts with years of experience guiding clients), the suggested contribution is around 10% of your annual salary. But it’s up to you – and any percent is a good start. Keep in mind — the more money you set aside, the more growth you will see. If you wait until you’re 40 years old, you will have missed out not only on 20 years of savings, but on 20 years of potential growth.

How do taxes work?
Any money you put into a 401(k) is “pre tax” – so you get to defer paying income taxes. There are a couple of ways this benefits you. Let’s say you’re making $45,000 a year, and you set aside 10% ($4,500) for your retirement account. You’ll now only have to pay income taxes for a $40,500-a-year salary. The less tax money you pay out this year, the more money you have to spend as you please. You will eventually pay the income taxes on the money you’re setting aside once you start withdrawing from the account. The good part? After you’ve retired, your tax rate will be lower than it would have been otherwise.

How does employer matching work?
Another major perk of a 401(k) is that many companies offer matching funds, typically up to a certain percentage of your income. Let’s go back to that $45,000 salary. Your employer may offer to match 100% of your contributions for up to 10% of your salary. So, if you’re contributing $4,500 (10% of your salary), your employer will also contribute $4,500. This is free money that is put into your 401(k). Let us repeat: free money.

What should I invest in?
Part of setting up your 401(k) is deciding how you want your money invested. The way you invest your money affects how much your money grows in your account, so this can be tricky. You will likely be given a list of options — like bonds, stocks, or mutual funds—and it’s up to you to choose the best fit. Do your research and weigh the risk factors before alloting your investments.

For more money saving tips and advice for college students, check out Barnes & Noble College’s blog, TheCollegeJuice.com.