Every year, lists circulate of the most-searched questions and terms on Google, Bing, Yahoo and other search engines. I always get a kick out of the off-the-wall things people type into search engines. Things like “why do men have nipples?” “am I a vampire?” and “do women fart?” have all been on some of the g-rated things on those lists. Typing in “Florida man…” always gets some interesting results too. Good for Your Wealth is uncovering and diving deeper into the most-searched personal finance questions. And we’ll answer them in this article. Here it goes!
10. What is a 401k?
A 401k is a retirement account typically provided by an employer. Today’s 401k (or 403b for educators) has replaced most “good old days” pensions. The 401k puts the employee in the driver’s seat for retirement savings. Many employers match contributions up to a certain percentage. For instance, some may match 100% of the first 5% of contributions. This means if you put at least 5% of your paycheck into the 401k, the employer will also contribute 5%. This is a 100% return on your money, so it is extremely important to at least contribute up to the match. Otherwise, you are losing out on that 100% return on your money. Check out Bucket Retirement Account Contributions in the Right Order to learn more about the ideal order of retirement savings. A 401k is not a type of investment. It is an account used to purchase various investments, including stocks, mutual funds, bonds and other types of investments.
One benefit to a 401k is that most are tax-deferred (if it is not a Roth 401k). This means that the money that you put in from your paycheck does not get taxed when it goes in. However, when it comes time to retire, the withdrawals you make from the account are subject to tax. If you withdraw before age 59 1/2, those withdrawals are subject to penalties. However, if you play your cards right, there are ways to minimize your tax burden.
The quality of an employer’s 401k retirement plan is very critical to your ability to meet retirement goals. Ask potential employers what their plan looks like before you accept an offer. Negotiate a higher salary if the employer doesn’t have a good match (e.g. at least 5%).
9. Is a 401k an IRA?
A 401k is different from an IRA, also known as an Individual Retirement Account. While a 401k is typically an employer-provided retirement account , an IRA typically serves as a retirement account for those who don’t have access to an employer-sponsored retirement account. IRAs, however, can also be used by those who have a 401k with an employer as a means for saving even more for retirement goals. Similar to a 401k, an IRA is NOT an investment. It is a retirement account that you use to purchase investments to save for retirement. As of 2022, a 401k has a maximum annual contribution of $20,500 ($27,000 if you’re 50+). An IRA, on the other hand, has an annual contribution limit of $6,000 ($7,000 if you’re 50+). An IRA comes in two main forms, a traditional IRA and a Roth IRA.
8. What is the difference between a traditional IRA and a Roth IRA?
The major difference between a traditional IRA and a Roth IRA is how each is treated for tax purposes. Contributions to a traditional IRA go into the account pre-tax, but when you begin withdrawals, those withdrawals are subject to tax (it is considered income). With a Roth IRA, on the other hand, money goes in AFTER tax. While you don’t get a tax break today when you file your taxes with a Roth IRA, the money you’ve invested in the account grows tax-free and can be withdrawn free of tax later on as well.
The other benefit is that Roth IRAs are NOT subject to RMDs (required minimum distributions). RMDs require that the holder of a 401k or traditional IRA take mandatory withdrawals starting at the age of 72. This is the government’s way of getting back some of the tax benefit they gave you when you contributed to the account. You can postpone withdrawals on a Roth IRA, on the other hand, and let it continue to grow. To see a breakdown of some of the differences between the types of retirement accounts, check out Roth IRA vs. Traditional IRA – Which Is Right? And How I Use Them In My Retirement Plan.
7. How much of a house can I afford?
If you’re in the market for a new house, do not confuse “how much can I borrow” with “how much can I afford.” Banks are in the business of lending money and charging interest to make money. Some will shell out far more than you should be borrowing. How much you can afford is what you want to focus on. First off, the best financial move when buying a house is to have at least 20% to put down. This will ensure you avoid private mortgage insurance (PMI). PMI is a drag! PMI adds $30-$70 to your monthly payment, and it can be a challenge to get it removed, even once you’ve hit 20% equity in your house.
As far as how much you can afford? A good rule of thumb is to keep your monthly mortgage/housing expenses to 25% or less of your monthly take-home pay. Your monthly housing expenses include principal, interest, property taxes and HOA fees….and PMI too if you go that route. By buying on affordability, you are avoiding the dilemma of being “house poor” and are able to put more of your funds to work on investments.
6. What is a SEP IRA?
One of the many benefits of owning your own business is the ability to access a different set of retirement accounts than you can as an employee of a company. A SEP IRA is one of those self-employed retirement accounts. A SEP IRA is a type of Individual Retirement Account. It allows you as the owner of the company to put up to 25% of your net earnings aside pre-tax into the account. For 2022, that is up to $61,000! If you have employees, the SEP IRA enables you to make contributions to accounts for your employees as well. Most brokerages such as Vanguard and Fidelity offer a SEP IRA.
5. What is the maximum 401k contribution?
For 2022, the maximum 401k contribution is $20,500. If you and a spouse are both employed, each can contribute the $20,500 max. If you are age 50 or older, you can contribute an extra $6,500 in what are referred to as “catch-up contributions” which brings it to a $27,000 total maximum contribution. The maximum contribution for a 401k is separate from the maximum you can contribute to an IRA. An IRA (both traditional and Roth) has a maximum contribution of $6,000 for 2022. You can contribute to both types of IRA, but the maximum cannot exceed $6,000 total across the IRAs.
4. How much should I save for retirement?
The best way to determine how much you should save for retirement is to first determine the monthly expenses you anticipate when you retire. It is flawed to simply take a percentage of your current income to determine your retirement needs. A lot of calculators do this. If you are someone who saves a large portion of your pay today, that may not continue when you retire. Additionally, there are expenses you may have that exist today (kids, mortgage, etc.) that may not be there upon retirement.
It is best to figure out your anticipated monthly expenses, then multiply that by 12 to get an annual figure. Then, by using what is known as the “4% rule of thumb,” multiply your anticipated annual expenses by 25. This will tell you how much you need to have saved in total in order to retire comfortably (and have it last for 30+ years). If you anticipate part-time work, social security or other payments monthly, you can deduct that from your monthly expenses before multiplying by 25. Check out What Is the 4% Rule, and How To Apply It To Figure Out How Much You’re Going To Need To Retire to learn more and check your numbers.
3. What is a Health Savings Account (HSA)?
A Health Savings Accounts or HSA is a tax-advantaged account that allows a person who is enrolled in an HSA-qualified health plan (typically with a higher deductible) to contribute money free of tax to an HSA. That money inside the account can be invested and the earnings then grow free of tax. Then, if you use the money for qualified health expenses, you pay no tax on the money coming out of the account. It is a brilliant way to gain wealth. It is also an amazing way to fund your health expenses if you decide to retire early (prior to the time you’re Medicare eligible at 65). Check out The Power of a Health Savings Account to explore more of the benefits.
2. How do I withdraw from a 401k?
I assume the people on the search engines ask this question in the context of accessing 401k money prior to retirement. My advice on that is….don’t do it. Even if your employer offers a 401k loan program, any time you take money out of a 401k, you are losing money, as that money is not able to be hard at work, earning returns on investments. It can be very tempting to “dip into the 401k piggy bank,” but don’t do it unless you absolutely need to. From the standpoint of accessing 401k money at normal retirement (59 1/2), most 401k providers offer the ability to set up direct deposit. You simply instruct your provider as to from which investments you want the money to come.
1. When can I retire?
The most searched personal finance question is no surprise…focused on the “when” of retirement. Whether you’re burnt out with your job or simply just desire something different, retirement is the ultimate goal. Even just knowing you can retire changes your day-to-day dynamic. So, how do you know when you can retire? The answer involves knowing when you’ll hit your FI or financial independence number. That number we referenced in question #4. There are several apps that can give you specifics on at what age you’re projected to reach your financial goal to retire. One such app is Wealthfront. Although this company sells investments and accounts, they offer free access to their app. The app aggregates all of your accounts into one view. You can set goals, including your ideal retirement age. The Wealthfront app tells you if it is “a stretch” or if you’ll retire “comfortably” based on information from your accounts as well as some questions you answer. I really like the insights it provides.
In closing
There are obviously lots of questions that people have out there on personal finances – ranging from retirement to savings to home buying. What are your questions?