It Pays (Literally) to Start Early

At the very least, read until you get to the pretty graph below. If your eyes glaze over after that, feel free to get back to your YouTube video of cats eating ice cream.

In my previous post talking about the difference between a 401(k) and an IRA I mentioned that regardless what type of retirement account you set up, it’s really important to start saving as early as possible. Now it’s time to drive that point home as hard as I can.

I can’t stress this enough – even if you can’t save a lot of money, just contribute as much as you can each month. One incredibly important fact is how detrimental it can be to wait to contribute to a retirement account. Let me throw some numbers at you so you can understand how this works.

Here is a poignant image taken from Vanguard that shows two different people who start contributing to an invested retirement account 10 years apart.

The image illustrates exactly why starting earlier with smaller amounts outweighs larger contribution amounts later.

In the situation above, you could invest half the amount of your friend and for half as long and still end up with a larger amount at retirement simply by starting 10 years earlier.

This graph assumes you both invest in the exact same portfolio and those investments grow overall 6% year after year, simply to illustrate the point. Really think about that…simply starting to invest now means you could end up with more in retirement than someone else who invests twice as much of their money as you but waits longer to start saving.

The reason starting earlier matters so much is because as your retirement accounts grow, the money you earn allows you to buy more investments (bonds/stocks/etc) which allows your money to grow even faster. This is the idea of compounding.

So Aaron, if I’m 35 and haven’t started investing should I pretty much give up now? Absolutely not. The best day to start contributing to a retirement account is today. Yes, you will need to save more to reach a healthy amount in retirement than someone who started earlier but you can absolutely do it.

Aaron, my company does a match on my 401(k), what does that mean? That means you literally get free money from you company if you contribute to you retirement account. They will put in some percentage of their own money into your account based on how much you contribute. If at all possible you should at least be contributing enough to get this free money.

Ok, this is all cool but how do I even start a retirement account? It sounds complicated and like a pain the a** to do. It may not be the most exciting process, but it isn’t difficult. If you can walk through TurboTax to get your taxes done each year, you can definitely do this. If you company offers a 401(k), 403(b), or something like those then it is likely as easy as contacting HR and letting them know you’d like to contribute a percentage of your paycheck to that. If you aren’t provided a retirement account option through work, you can start up an IRA. Take this advice with a giant grain of salt, and do your research first, but if you are looking to start a retirement account I would recommend at least taking a look at Vanguard’s target age retirement accounts. Give them a call if you have any questions about how those work. Feel free to contact me directly if you want to know my reasons for mentioning that IRA.

There are many considerations to keep in mind while picking a retirement account, I will write a completely separate post in the next month or so on that topic.

CORE MESSAGE – please take retirement planning seriously today so that you aren’t scrambling in the future. My challenge to you is to start contributing whatever amount you can to a retirement account today. $25/paycheck, $200/month, whatever. Just start today.

 

References/Links

Differences Between a 401(k) and an IRA

Not to be confused with 401(k) vs. NRA. That wouldn’t even make sense.

In the last post I explained the differences between a Roth 401(k) and a Traditional 401(k). Both of those are retirement accounts that may be offered by your employer as an employee benefit. However, the reality is that many employers today do not offer a 401(k) to their employees. There are many other options for retirement savings and one of the most popular options is some form of IRA.

An IRA is an Individual Retirement Account and has the same purpose as a 401(k): save money for retirement. Also, an IRA is something almost anyone can set up as opposed to a 401(k) which is offered only through an employer!

Shared Traits:

  • Intended for people putting money away for retirement
  • Both Roth and Traditional types exist for both 401(k)’s and IRA’s
  • One can put money away in both a 401(k) and an IRA if the contribution limits are upheld
  • Both have annual contribution limits
  • There is an option for both to invest the money you put into them

401(k):

  • Offered only through an employer
  • No age limit on contribution
  • $18,000 annual contribution limit between Traditional and Roth (2017)
  • Usually more limited selection of investment options
  • This is typically funded from money coming directly out of your paychecks
  • You must start taking required minimum distributions at age 70.5

IRA:

  • Offered through large financial institutions (banks, mutual fund companies, brokerage firms)
  • $5,500 annual contribution limit between Traditional and Roth (2017)
  • Typically a wider range of investment opportunity
  • Traditional IRA
  • Roth IRA
    • No contribution age limit
    • There are no required minimum distributions as long as you are alive
    • Can withdraw any amount of money you have contributed at any time
    • You are not eligible for a Roth IRA if your Annual Gross Income is $193,000 married or $131,000 single (2015)

If your employer doesn’t offer any retirement benefits/options I would highly recommend looking into getting some form of an IRA. The sooner you start contributing (even small amounts) the better! Seriously, read the example in this link (it’s short) to see how crucial it is to start putting money in a retirement count as early as possible. My next post will expand upon why it is so important to start saving for retirement ASAP.

Thanks for reading and as always, feel free to correct/dispute/lash out at/love me in the comments below!

Sources/Further Reading:

Understanding a 401(k)

Foreword – This got a bit dense but I tried to make it as bullet-pointy as possible. If you see all these things below and you’re like “nope, I’m not going to read all that” then at least read these next two sentences. The sooner you start contributing to a retirement account (even small amounts) the better! Seriously, read the example in this link (it’s short) to see how crucial it is to start putting money in a retirement count as early as possible.

——–

When I first started my job I was handed a giant binder full of employee benefits, some of which I was auto-enrolled in and some of which I had to opt-in to in order to participate. Needless to say, I was a bit overwhelmed.

One of these benefits was to choose to contribute to a Traditional 401(k), Roth 401(k), or both. I spent a decent chunk of time trying to decide which of these was the “better” option, or even what they are. (Hint: they are not signing bonuses of $401,000 that your employer gives you because you’re super good at what you do. Sadly.)

Traditional 401(k) and Roth 401(k) are both types of retirement plans offered by some employers.

They both offer the same end goal: take money from your paycheck and save it for retirement so you don’t have to survive by eating expired cat food (although you sure can if you want to). Below I’m going to talk about some of the differences between these two types of 401(k)’s.

Shared Traits – What is a 401(k)?

  • Both are funded by setting aside a percentage of your paycheck to go straight from your employer into this retirement account
  • You cannot withdraw from these until you reach a certain age (or meet a couple other situational requirements, check resources below) without incurring large penalties (fees)
  • Sometimes employers will offer to match employee contributions up to a certain dollar amount (free money!)
  • There is a total limit of how much can be contributed to both Traditional and Roth combined each year
    • The amount you can contribute to each is regulated by the IRS and can change each year
    • The current max contribution for 2017 is $18,000 total between both
  • Your contributions are always 100% vested immediately
    • Regardless of how long you’ve been at your job when you quit, anything you put into your 401(k) is yours
  • You must starting taking distributions out of these plans when you turn 70.5 years old
  • When you leave your company you can either roll your 401(k) into your next employer’s plan or roll it into an IRA (I’ll explain what that is in the future)
  • These plans typically allow you to invest the money put into them, managed by you or through your employer (or whoever they get to manage it)

Traditional 401(k)

  • Money taken from your paycheck is taken out pre-tax
    • example: Your paycheck is $2000. You have $300 taken out for your Traditional 401(k). You will only pay tax on $1700 for that month.
  • You pay tax when you start receiving money from this, when you retire

Roth 401(k)

  • Money taken from your paycheck is taken out post-tax
    • example: Your paycheck is $2000. You have $300 taken out for your Roth 401(k). You will pay tax on the full $2000 for that month.
  • You DO NOT pay tax when you start receiving money from this, when you retire

The big difference between them is when you pay taxes on the money you put into them. With Traditional you are taxed when you withdraw the money in retirement and with Roth you are taxed when you put money into it. Something to consider in both situations is which tax bracket you are when you pay taxes. Theoretically as you grow in your career over 30-40 years you will move up to higher tax brackets over time. Although it might be nice to get a tax break while you are just starting out (Traditional), it might also be nice to avoid paying higher taxes when you retire (Roth).

Protip: find out if your employer matches any percentage of your contributions to your 401(k). If they do, take advantage of that free money as much as you are able!

My next post will be about the similarities/differences between Traditional/Roth 401(k)’s (employee benefit) and Traditional/Roth IRA’s (most people can get). As always, sound off in the comments below if I was completely wrong about anything above or with any feedback. Thanks y’all!

Sources/Further Reading:

The Very Basics of Health Insurance

This post could also be titled “Why Am I Paying Hundreds of Dollars Each Month and Then Still Owe My Doctor So Much Money?” It could be, but that is way too long of title.

Healthcare plans. It’s annual enrollment at your company (or on the public marketplace) and you have to evaluate your choices…but what do you even look for? There are some words and numbers you are going to want to pay close attention to. Here is a list of a few of them along with their descriptions.

Premium – The amount you pay each billing period (typically per month) to maintain your health insurance coverage.

Deductible – This is the amount of money you have to pay before your health insurance plan covers any of your costs. There are some health insurance plans that have a few benefits before you reach your deductible but typically you have minimal, if any, coverage before you pay this amount out of pocket. It’s not unusual for a deductible to be anywhere from $500-$3,000 depending on the plan.

Coinsurance – With a deductible plan, this is the percentage you pay for a category AFTER you meet your deductible. So for example, we will pretend you have a plan with a $1,000 deductible and your coinsurance is 10% after you pay that much out of pocket. If you get a medical bill for $2,000 dollars, you would pay $1,000 of that out of your own pocket and then only 10% ($100) of the remaining $1,000. Isn’t math fun?!

Out of Pocket Maximum – This is an important number! This is the largest amount of money you will have to pay (aside from premiums and potential copays) in a given coverage year regardless of what your total medical costs are. After you pay this amount, your health insurance provider will cover the rest. If your out of pocket maximum is $2,000 and you get a bill for $3,000, you’ll only be paying $2,000. If you get a bill for $4,000, how much do you think you’ll be paying? That’s right, $2,000! See how easy all this is?

Copay – I mentioned this one in the previous section, did you catch it? This is the amount of money your plan says you’ll pay for a given service. It could be a $10 copay for name-brand prescriptions, in which case you just pay $10/prescription regardless of deductible or any other part of your plan. It could also be that you just pay a $30 copay per doctor office visit. Some plans are set up primarily based on copays instead of deductibles. Copays also usually do not contribute to a deductible.

There are four major types of healthcare plans – Health Maintenance Organization (HMO), Preferred Provider Organization (PPO), Exclusive Provider Organization (EPO), and Point of Service Plan (POS). Out of these, PPO and HMO are the most popular so I will give a very brief overview of each.

HMO – These plans typically have the cheapest premiums but are also usually very restrictive on which doctors you can go to and still be fully covered. A referral is usually needed to see specialists.

PPO – There is a list of preferred providers that allow you to be seen with the greatest amount of insurance coverage. However, you are allowed to go to any provider outside of that network and still be covered but at a much lower level of coverage. For example, it wouldn’t be abnormal for a plan to have a $1,500 deductible for all in-network costs but have a separate $2,500 deductible for any providers you see who are out of network. A referral is usually NOT needed to see specialists.

Here are two made up plans, two made up scenarios, and two made up decisions. This is not advice, this is an example of how two made up people might think about choosing a plan and weighing the trade-offs.

 

Plan 1 – $250/month premium, $1000 deductible, 10% coinsurance after deductible, $2,000 out of pocket maximum.

Plan 2 – $80/month premium, $2,500 deductible, 10% coinsurance after deductible, $4,000 out of pocket maximum.

Situation 1 – a 22 year old female is looking for health insurance. She is rather healthy and goes to the doctor 1-2 times per year. She decides to choose to do plan 2 because she believes it is unlikely based on her health history that she’ll ever hit the $2,500 deductible. Due to this, she is saving $170/month in premium costs but will pay much more on this plan if she has many unforeseen healthcare costs.

Situation 2 – a 66 year old male is looking for health insurance. He has been diagnosed with diabetes and will likely be needing heart surgery in the upcoming year. He decides to choose plan 1 because although the monthly premiums are higher, it is very likely his health care costs will be not only above the $1,000 deductible, but also far beyond the out of pocket maximum. Although he will be paying much more in premiums, he will be saving a lot of money with this plan overall.

 

As you can tell, there are many considerations when comparing health insurance plans. It’s up to you to find the best balance of these, specific to your situation. As with any insurance or warranty, you are essentially making an educated guess and hoping it pays off. Good luck!

P.S. If you ever don’t understand a part of your health insurance plan, call your provider! They will answer any and all questions you may have about your plan. I highly recommend doing this since it could end up saving you a lot of money in the future!

 

Links for further reading:

http://www.webmd.com/health-insurance/types-of-health-insurance-plans#1 – talks about different types of healthcare plans

https://www.reddit.com/r/personalfinance/comments/41u4q5/health_insurance_101/ – a great reddit post similar to this one that goes into much greater detail. If you want to learn more (you should!) I highly recommend reading this. Reddit is not the most credible source typically, but everything I’ve read/learned from more reputable sources completely matches what this user says in this post.

An Introduction

Personal Stats:

  • Aaron
  • 24 Years Old
  • Male
  • Bachelor of Arts, Computer Science
  • Programmer
  • Personal Finance Qualifications: I Browse /r/personalfinance a lot and google a bunch
  • Amount of $$$ currently invested: However much is currently in my 401k/Roth(k) (not much)
  • # of stocks owned aside from 401k: 0

When you look at those amazing qualifications above you’re probably wondering: “why would I trust this guy with my hard earned ca$h?!?!”

That’s fair.

Here’s the deal. When I got out of college I had almost no knowledge of anything having to do with personal finance (thanks College). I spent a ton of time reading and trying to sift through detailed explanations of things I really only wanted a high-level overview of, including some basic pros and cons of different options. I’m not qualified to give advice and will be doing my best to only share facts I have found from credible sources. Take everything I say with a grain of salt, knowing I am trying to explain these topics as factually as possible.

My plan is to create posts that:

  • are short(ish)
  • give a high level overview of a personal finance topic
  • give at least a couple more resources from people more intelligent than myself if you happen to want to learn more
  • make potentially complex topics easy to understand for anyone

I invite you to join this ride of learning about these important topics!