A 401k plan is an employer-sponsored retirement plan. Odds are if you work at a for-profit company you will have a 401k plan made available for you to participate so you can save for retirement. Each 401k plan has its own set of rules. For example, some plans may require you to wait three months before contributing, some plans will offer a great match, some plans offer a Roth option and some plans might even enroll you automatically when you start working.
401k's are voluntary accounts, meaning you only participate if you want. You can also start and stop contributions at any time. The big benefits of the 401k plan are the tax benefits, the employer match and the convenience of payroll-deducted forced savings. The major drawbacks of the 401k plan are the access to your money and depending on your plan, the fees and investment options available inside of the plan. You need to be very aware of the fees charged in your specific plan. Watch the video above for more information about 401k plans.
What is a 403b Plan? A 403b plan is a retirement plan used by non-profit organizations, public school districts, certain religious groups, certain hospitals, and government organizations. It works very similarly to a 401k plan. For example, your contributions are made pre-tax and are payroll deducted, the funds grow tax-deferred during your working years and then withdrawals are taxed as ordinary income in retirement. A major difference is most 403b plans use an annuity contract (Tax Shelter Annuity), which is provided through an insurance company. A big problem with these annuity 403b accounts are the fees. Most people have no idea how much they are actually paying in these accounts because it is hidden very well. If you currently contribute to a 403b plan your homework assignment is to go figure out how much in actual dollars you paid in fees over the last year.
What is a 457 Plan? A 457 plan is another type of employer-sponsored retirement plan offered to state and local government employees along with some non-profit organizations. It is also known as a deferred comp plan and has many similarities to a 401k plan.
One very nice feature if your employer offers both a 403b and a 457 plan is that you can contribute the maximum amount to both. So you could actually max out your 403b contributions and max out your 457 contributions allowing you to save double the amount in retirement plans than just a typical 401k participant can.
Another cool feature of 457 plans is that there is no 10% IRS penalty for early withdrawals once you separated from your employer. So if you retire at age 45 from the police department you can start taking withdrawals from your 457 plan without a penalty. You will always pay income tax on withdrawals similar to a 401k or 403b, but not 10% early withdrawal penalty
What's up, everyone, and welcome to the School of Personal Finance. In this video,
we're going to be talking about the three keys to success when investing in retirement accounts.
So that's like your 401k, 403b, Roth IRA, traditional IRA, 457 plan. So let's get to it.
So before I get into the three keys, let's just throw out there some of the obvious stuff and get
it out of the way. Like the first one is you just need to get started, start contributing.
The second one is you should always take advantage of the employer match. That's free
money. You need to at least make sure that you're doing that. The third one is you should increase
your contributions each time you get a pay raise so you don't really miss it.
Those are like the common things that we should at least lay the groundwork with.
So now for the three keys to long-term success in investing in these plans in order of importance,
in my opinion, the first one are fees. Fees are the killer of growth and happiness.
You do not want to be in funds that are going to charge you high fees. You know,
the great thing about technology and where the industry has gone in the last few years
is that it's very simple to manage your own 401k or IRA accounts. You really don't need to pay
to have somebody actively manage those funds for you. Now, I'm all about paying for financial
advice, but I think the best way to do it is to pay for a financial planner, to pay somebody who's
actually going to put together a financial plan for you and look at all aspects of your life.
With technology, you don't need to pay somebody to manage the actual investments inside of the
account for you. You could use index funds. You could use target date retirement funds.
There are better ways to do it than to pay a fund manager one and a half percent of your money to
manage that account for you. So when it comes to fees, how much should you be paying in your 401k
or IRA? Now with an employer-sponsored plan like a 401k or a 403b, you don't have all the control.
You don't really have a say in what options are available in the plan. Your employer hires
whatever company it is and they offer the plan to everybody. So sometimes you get stuck with
really crappy funds that have high fees. And when you're in that situation, it really is better to
not use that plan, to actually just do IRAs and find other ways to save because the fees will
really kill you. You should not have any upfront sales fee to buy any funds inside of your retirement
plan. And the expense ratio is what it's called. That's how you determine how much you're actually
paying for a fund. So if you're one of the lucky ones out there that has Vanguard inside of their
401k plan and they offer these funds, the expense ratio, it might be below 10 basis points. That's
like one-tenth of one percent. So if you have a hundred thousand dollars inside of your 401k
in the fund like that, the fee would be about a hundred dollars a year, which would be great.
If you're stuck with a crappy fund that charges two percent a year, that's two thousand dollars
a year on a hundred thousand dollar amount inside of your 401k. So year after year after year, I mean
that makes a tremendous difference. So you want to look at how much you're paying in fees inside of
your retirement accounts. And now if you're self-employed or if you have traditional
IRAs or Roth IRAs and you manage your own funds, then you have control. You could go and choose
those Vanguard funds or Schwab funds that have very, very low expense ratios. It is going to make
such a tremendous difference from now until the time that you actually retire and could touch
this money. We're talking tens of thousands of dollars, maybe even a hundred thousand dollars
if you have a lot of money in these accounts. So it's very important to invest in low cost
index funds inside of your 401k, 403b, IRAs, 457, whatever it is, low cost funds,
big time importance. My second key to success kind of piggybacks on the first one a little bit,
and that is that less is more inside of these accounts. Gone are the days where you need like
12 funds to put together a portfolio inside of your 401k or your IRAs. You could really have
two to three funds and be very well diversified and have everything that you need just between
those two to three funds. So again, they need to be low cost funds, but you could do it sometimes
with just one fund and that's with the target date retirement funds. So these have become
very popular over the last 10 years and they are a great option if they are good target date
retirement funds. And that means that they're low cost. So again, going back to Vanguard,
they offer very low cost, well-managed target date retirement funds. And all you need to do
is choose the date that corresponds with when you're going to be retiring. And it doesn't have
to be exact. So if you're going to be retiring somewhere in the ballpark at 2055, then that's
the target date retirement fund you would pick. And that's going to be a more aggressive fund
because you have a very long time until you're going to be retiring. Compared to the 2020 target
date retirement fund, that is going to be a much more conservative fund because they are managing
it with the expectation that you're going to be retiring around the year 2020. So these funds,
they will automatically rebalance themselves. They have a glide path where they're going to
get more conservative as you get older and start to approach retirement. So these are really set
it and forget it type funds. So if you don't want to think about this stuff, if you don't want to
worry about it, you could choose to just contribute in a target date retirement fund. And then it's
hands off. And if you have a low cost option like a Vanguard fund in there, then you're paying very
low fees and you don't have to manage the account. It's just going to go for you. All you got to do
is throw the money in there and let it go. If you're in your 20s and your 30s, the move is to
be aggressive. Go with the flow. If the market goes up, market goes down, don't even worry about it.
Just be aggressive because that's the best chance you have at making that money grow to be where
you need it to be by the time you're going to retire. A good rule of thumb is to take the number
120 and subtract your age from it. That's the amount that you should have in stocks or ballpark.
So if I'm 40 years old, I'd take 120 minus 40. I should be somewhere around 80% in stocks inside of
my retirement accounts because I still have 20 years before I'm touching that money. So over a
20 year period, history has taught us that I have a much better chance of getting a higher rate of
return by having it invested in the stock market. Now as you get closer to retirement, then it's a
little bit different. If there's money in there that I'm going to be using in the next 5 years,
7 years, I might want that money to be a little bit more conservative, to be a little bit safer
so that I know it's going to be there when the time comes for me to use it. But any money that's
10, 15, 20, 25 years out, you want that money invested for growth. That's the only way you're
going to get that big pile of money that you want so that when you retire, you could go live the
good life. And then my third and final key to success is not to listen to the outside noise.
No matter what is going on in the world with politics, with trade wars, with whatever it is,
this stuff has been going on forever and the markets cycle through it. The markets go up and
down. We have crashes, we have boom periods, but over the long term, the markets grow on an average
of 10% in that ballpark. So yes, there are going to be years like 2008, 2009 where you could lose
50% of your portfolio and it's gut-wrenching and you're going to want to throw up all over the
place. But the best thing to do is to just sit tight, continue to contribute, and go through it.
Don't try to be one of those people who says, oh, the market's so bad, I need to get out. It's
always the wrong decision. Or, oh, the market's so great, I need to put more money into it.
So before I was making these videos, I was managing $100 million worth of retirement
accounts for individual clients. So I used to get a very good idea of how people were feeling out
there because that made up a lot of clients. So if I was getting a ton of phone calls with panic,
then I knew that it was probably getting to be a good time to start buying. If I was getting tons
of phone calls of people saying, I want to give you all this money to invest, I need to get in
this market. It's taken off. I need to participate in it. Then I knew we were getting right around
that time where we should be selling and getting out of the market a little bit. But timing the
market is a very, very hard game to play. And usually the crowd is on the wrong side of that
trade. So my best advice for people is just go with it. You don't have to get in and out. You
don't have to make these moves. Odds are you're going to be wrong. So just stay with the flow,
keep contributing. That's the best way that you're going to be able to participate
in the average that the market has done over the last 80 years or so.
All right, that's it for this one. Thanks for watching. Hit that like button. Remember 401ks,
403bs, IRAs, they are great ways for you to save for retirement for the future, but you have to
make sure that you're doing it the right way and that you're taking advantage of the opportunities.
Hopefully this was helpful to you. Please hit that like button. Subscribe to my YouTube channel
if you have not already. Check out schoolofpersonalfinance.com. Get on my email
list over there. I will see you again next time. Thanks a lot. Bye.
