After four years of working (and playing) hard, Adam graduated from Rutgers University with honors. In addition to his shiny new diploma, he also had a great job lined up and the future certainly seemed bright. His grandmother Margaret, whom also shared his alma mater, was especially proud. They were always close, and on his graduation day, she passed him a small blue envelope. Adam thanked her and placed the envelope in his pocket as they headed out to celebrate the occasion with the family.
Back in his room that evening, Adam tore open the envelope and was surprised when a carefully scripted invitation fell out. He shook his head and smiled; apparently, Grandma was not done celebrating yet.
On Sunday, Adam donned his favorite jeans and a well-loved Rutgers t-shirt and headed to the local pub where he and his grandmother had shared many a meal. As he walked in, Margaret beckoned him from her favorite corner booth. The two exchanged an affectionate hug and took their seats. Mere seconds later, the server appeared with two pints as his grandma gave him a huge grin. Margaret raised her glass as she proclaimed: “A Toast: To Financial Freedom!”
Adam grimaced as he slowly shook his head and reminded his grandmother that he had not yet earned his first paycheck and did have a fair amount of student loan debt though he acknowledged that he was fortunate to have had help from his family and had considerably less than many of his friends.
Not to be deterred, Margaret pressed on. “You know Adam; your grandfather and I have a great life together. We started out with nothing, worked hard and saved, and we retired very comfortably. I think I know something about financial freedom and invited you here today so I can share some tips as you are starting out.”
Adam nodded and finally raised his glass to cheers his grandmother. They both took a big sip and settled in. Margaret began…
“Okay then. One of the most important things that I learned is that it’s never too early to start planning for your retirement. But let’s focus on just one tip for today… your 401K.”
“My 401-What?!” asked a bewildered Adam.
“Your 401K. It’s going to be your first step towards financial freedom, and you must begin right away! A 401K is an employer sponsored retirement plan. It is a great tool! Here’s how it works. You get to choose an amount to be deducted from each of your paychecks, the company deposits that amount to your 401K (and it is pretax which helps reduce your income tax today) and then most employers match your contribution up to a certain amount, so you effectively receive even more than your salary each year in compensation! It’s free money, kiddo! During your first week of work, you will be given enrollment information on many things, and this is one of the most important. You will want to enroll in your 401K immediately up to that employer match, so you do not leave that free money on the table.”
“Grandma, I haven’t even seen my first paycheck and you’re already having me chop it up!” Adam protested.
“I know honey, but that is the beauty of setting things up right away. If you never see that additional amount in your take home pay you will never miss it. It is a small price to pay to set up your financial future. Let’s be honest… I haven’t steered you wrong yet, have I?!”
Adam chuckled and reluctantly agreed with his grandmother as she went on: “The greatest thing about the 401K, aside from the free money of course, is the power of compounding.” Margaret laughed as Adam’s eyes widened and continued, “Let’s use simple numbers. Assume you are making $50,000 a year and contribute 5% to your 401K. If your employer matches an additional 4% of your salary, your total annual savings is $4,500. At your age, you can invest rather aggressively so you can anticipate 10% growth per year. Now if you just put that money under your mattress (which by the way my mom would have advocated for) you would have just $180,000 in forty years when you are approaching retirement. But with the power of investing and compounding, you’ll have well over $3 million dollars! Imagine that!!”
Adam exhaled with a “Wow.”
Margaret tipped her glass toward Adam and exclaimed, “Well I think I’ve given you enough to think about today my little millionaire. Shall we continue our lesson next Sunday, same place?”
Adam laughed and said, “Sure, Grandma.” Margaret smiled from ear to ear and leaned in close as she whispered, “Great. Now that the business of the day is out of the way, tell me about that sweet girl you were speaking to yesterday!”
Retirement 101: Lesson One: Enroll in your 401K immediately up to the amount of the employer match. (For example, if the employer matches 100% of the first 3% and 50% of the next 2% for a total possible match of 4%, then you would want to contribute 5% to maximize that match.) The employer match is free money and is thus the best, risk-free return on an investment that you will ever get. Add into the mix the power of compounding and the tax benefits of a 401K (or other qualified retirement accounts), and this is certainly the first step toward financial freedom.