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I’m starting my first job out of college. How do I understand my company’s benefits such as 401(k) and choose the best option for me?
Congratulations! During your first job, you’ll want to investigate benefits from your employment beyond your salary, including options to save money for retirement and medical expenses. Although you have an entire career ahead of you, saving for retirement as soon as you start working is a smart decision! The money you set aside now will grow over time through compounding interest, which is when the interest on your savings accumulates interest. It pays to invest a small amount earlier than a larger amount later (see https://www.nytimes.com/guides/business/saving-money-for-retirement).
Reading and understanding your company’s benefits is one of the first tasks you should do during onboarding, because there is typically a deadline to make selections (example: 30 days for health insurance). While it might feel daunting, with a bit of research you can set yourself up for a successful financial future. First, you’ll need to differentiate the types of benefits offered. Then, you’ll need to assess your financial goals. Finally, you select benefits that align with your goals.
Options to save for retirement
A 401(k) is a retirement savings plan offered through your employer. If you are employed by a public school, charity, or other nonprofit, you fall under a similar plan called a 403(b). Employees contribute a percentage of income directly from their paychecks into the 401(k). Employers might provide additional benefits, such as contributing a fixed percentage of your salary into the 401(k) each year or matching your contributions up to a certain percentage. Make sure you participate in the minimum program requirement to earn the extra benefits, because it amounts to free money from your employer.
Beyond the minimum, financial advisors recommend allocating 10%–15% of your salary to your 401(k). You can select how your money is invested within the 401(k), including stocks, bonds, or a target retirement fund account, which is a blend of various types of investments. Be aware of two types of penalties associated with 401(k) plans: maximum contribution amounts and tax penalties. You can contribute annually up to the maximum amount set by the government (in 2022, it is $20,500). If you need to withdraw money from your 401(k) before you are 55, you will incur taxes and penalties.
Additionally, there are two types of 401(k) plans: traditional and Roth. Your employer might offer one or both. Contributing to a traditional 401(k) allows you to invest money pre-tax, and contributing can lower your taxable income. The amount compounds and grows tax-free, but during retirement, you will be taxed on the money you withdraw. The other option is a Roth 401(k), where your contributions are taxed before they are added to your 401(k), and all withdrawals during retirement are tax-free. Advocates of investing in a Roth 401(k) believe you’ll pay less in taxes in the long run, arguing that taxes on income generally increase over time, and you’ll likely have a larger taxable income in retirement than when you are early in your career.
If you want to save additional funds for retirement, or if your employer doesn’t offer a 401(k), you can open an independent retirement account (IRA). Like a 401(k), you can choose to open a traditional or Roth IRA, and you’ll be able to contribute up to $6,000 annually (in 2022). You can withdraw money from your traditional IRA starting at age 59½, while you can withdraw contributions from a Roth IRA at any time.
Managing health care expenses
The cost of health care can be a significant part of a family’s budget. Depending on the type of health insurance you select, you might have an option to save money pre-tax by opening a flexible spending account (FSA) or a health savings account (HSA) — and your employer might contribute additional money to these accounts, too, as an incentive.
If regular health care expenses are part of your budget, an FSA might be the option for you. The money that goes into the FSA account is predetermined annually and cannot be adjusted during the year. Your contributions are pre-tax; however, you have to spend the FSA balance on qualified health care expenses by the end of the year or forfeit the amount in the account.
Meanwhile, an HSA is an investment account with a triple tax benefit: The money goes in tax-free, can be withdrawn tax-free, and will be invested tax-free. Unlike the FSA, the HSA does not have a requirement to be spent each year. An HSA is a good option if you want to set aside some funds for future health care expenses. You must be enrolled in a high-deductible health care plan to be eligible to open an HSA.
Your financial future
What are your goals? Do you need cash to make a large purchase soon, such as a car or home? Do you aspire to retire early in life?
Creating a personal budget is the foundation of your financial future. Identify your sources of income (salary, gifts, etc.) and your expenses (housing, health care, loan payments, food, etc.). If there is money left over, choose how to allocate. Here is where a little bit of economics and reflecting on your financial personality can be helpful!
For example, Sen. Elizabeth Warren of Massachusetts recommends the 50/30/20 budget rule: Spend 50% of your after-tax income on needs, 30% on wants, and put the remaining 20% in savings.
You’ll also want to assess how you feel about money. The University of Missouri offers a short financial quiz that can give you some insight of your financial risk tolerance. Your family and friends can provide insight on past spending decisions, and your employer might offer financial counseling sessions. Seek information from multiple sources. When I entered the workforce, I didn’t understand the long-term outlook of an HSA and closed my account prematurely, leaving money on the table.
Aligning your risk tolerance with your budget and financial goals is a dynamic process that will change throughout your career. There is no right answer, and saving just a little will grow tremendously with compound interest. Putting money into a retirement account will start you down a successful financial path.
If you’re a collegian or young professional seeking advice on a personal or professional issue, please submit your question here: https://bit.ly/3ffqNTu.
Be on the lookout for an upcoming “Ask Alice” in the Voices and Views section of SWE Magazine.
Emily Carney (she, her), a human and organizational performance lead at Takeda Pharmaceuticals, provided the answer to this question. Carney graduated from Tufts University with a B.S. in environmental engineering and an M.S. in engineering management. An active SWE member, she currently serves on the editorial board.