Using a 401(k) for retirement planning is an excellent idea. It however isn’t the only vehicle for retirement nor should it be your only or first method for savings. In day 3 this article discusses your 401(k) and the place that it should play in your financial world.
Day 3 Changing Your Financial World In 30 Days
In day three, we take a look at your 401k and the role it should plan in your financial world. While important it isn’t the number one thing that you should be concerned about.
Day Number Three :Put Your 401K In The Proper Place
While your 401k is a great tool for retirement savings, it sucks for short term savings. You should take care of short term, emergency, savings before looking at long term savings.
When you withdraw money from your 401k, before normal retirement age, you run the risk taxes and penalties. This could create a cycle of savings, pulling out money, paying interest and penalties, becoming discouraged and then actually not saving. Therefore, I suggest that you not max out your 401k contributions until you have the proper amount of savings or at least the proper rate of savings.
You should not contribute to your 401k until you have your first $1,000. This gets you started on establishing your emergency savings. At that point, you can begin to consider starting your 401k contributions.
Once you start contributing to your 401k, I would limit my contributions to the level of matching by your employer. Example if your employer matches 100% of your contributions up to 5% then stop at 5%, don’t go to 6% automatically. When you have 12 months of your fixed monthly expenses saved i.e. mortgage, insurance, monthly food cost etc., then you should adjust your contribution level.
Avoid the temptation of adding more to your 401k automatically. The myth that your 401k saves on taxes is that, a myth. A 401k simply defers taxes into the future when you are more likely to be in a higher tax bracket and as a result will have to pay more taxes.
I would also suggest doing some homework and have your contribution allocations matching your risk tolerance. I would also revisit your choices on an annual basis. What you are comfortable with can change over time.