When you get your first job, there is a good chance that you are going to have to make some decisions about participating in a retirement plan right away. In some cases that decision will be made for you. If you go to work for a corporate dental office, there is a pretty good chance you will end up with the option of a 401k. 401k Retirement plans are less common in smaller and private practices, but it would still be beneficial to have a basic understanding as one will likely be recommended to you at some point in your career. One other thing to keep in mind is that you could also end up working as an independent contractor, in which case you would not be able to participate in the employer’s retirement plan although you could set up your own. There are other types of retirement plans but for the sake of brevity, we will focus on the 401k. Here are some things you need to know.
- Auto Enrollment – When a newly graduated dentist gets their first paycheck, they express to me a variety of surprises. The first surprise is how much is being taken out of their paycheck for things like taxes and workplace benefits. In many cases, they are also surprised to see that there is a retirement contribution being withheld from their paycheck even though they didn’t sign up. The first thing you should be aware of is that your employer can automatically enroll you in the retirement plan, requiring you to opt out if you don’t want to participate.
- Mutual Funds – Most of the time, your money is invested in mutual funds. You can think of those as baskets of differing stocks and bonds. Historically, buying stocks (ownership in companies) and bonds (lending money to companies and governments institutions) has in some cases provided superior rates of return compared to just leaving money in cash (i.e. a savings account). Note that mutual funds can lose money. And one other really important thing to keep in mind is that if you are automatically enrolled in a 401k, mutual funds are chosen on your behalf according to your retirement date. That usually means younger investors are invested in mutual funds more heavily weighted to stocks, which can experience substantial volatility. In other words, your money in your 401k could drop significantly. That’s not necessarily bad as volatility is a part of investing; you just need to be aware and to make sure that your money is invested according to your preferences. Determining your preference for risk can be a very complicated matter so you may need the help of a professional. Some 401k providers will provide assistance. But at minimum, be proactive when you get hired.
- Tax Deferral – One of the mechanics of a traditional 401k, is that the money you put into the plan is not taxed that year, but instead is taxed when you withdraw the money in retirement. Presumably, this occurs sometime after age 59 ½ . If you withdraw the money earlier than that, you will be subject to income taxes in the year you withdraw as well as a 10% penalty. (So don’t do that, and make sure you take steps to avoid being forced to. (For example, having a financial emergency and not having any money in short term savings could force an early withdrawal.) You may also have the option for a Roth 401k. A Roth 401k allows to you to contribute after-tax dollars which then grow tax free and are withdrawn tax free (as long as it’s after age 59 ½).
- Employer Match – Sometimes the employer will offer to match a percentage of your contributions. For example, if you put in $18,000 a year (2016 maximum), and your employer offers a 50% match, they would also contribute $9,000 to your account. Most of the time the employer will also set a cap on the amount of money they will contribute, such as a maximum of 5% of your salary. If your salary was $125,000, then your employer would only contribute $6,250, not $9,000 because the max is less than the match. Here’s a financial planning tip: You should almost always take free money.
- Vesting Schedule – Ah yes… “The Catch”. Most employers that offer a match don’t let you keep all of the money unless you stick around for a certain period of time. This period of time is referred to as the vesting schedule. A common vesting schedule is that you get to keep 20% of your money for each year you stick around. After 5 years, you would get to keep 100% of all of the employer contributions.
- Policy Loans – Most 401k plans give you the option to borrow the greater of $10,000 or 50% of your vested account balance, or $50,000, whichever is less. You can then repay the loan over a predetermined time period, and pay your account interest. Although it is an option you should be aware of, this is usually not the most ideal way to access money. First, the interest that you repay into your account is not tax deductible so you will pay tax on that money twice. You pay it first when you earn the money to put in as interest, and again when you withdraw the money in retirement. Another possible detriment is that if you can’t make a payment or you leave your employer and don’t have the resources to repay the loan, the loan balance could be considered a taxable distribution and taxes and penalties could follow. Use 401k loans cautiously.
Retirement plans can be a very powerful asset on your balance sheet. But make sure that you have adequate cash in a savings account. You don’t want to find yourself in a situation where you need money and the only place to get it is from your 401k. Just like the investments in your retirement account, it’s important to keep your balance sheet diversified. Another thing to consider as you are deciding if, and how much to contribute to your retirement plan, is your other goals and your plan for your student loans. If you want to get your loans paid off as soon as possible, it may be more prudent to focus your cash flow on your student loans. Or, if you plan on buying a practice, you might want to have cash available for that rather than locking it up until age 59 ½. There are lots of factors to consider so you may want to contact a professional for help. Good luck.
~Ryan Schulte, financial advisor, CFP®
Ryan is a new contributor to ASDA’s Money Monday feature. If you have any other questions for Ryan or ideas for a future post, leave a comment below!
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS).OSJ: 750 B Street #2740 San Diego, CA 92101 ,612-746-2200. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is an indirect, wholly-owned subsidiary of Guardian. WestPac Wealth Partners, LLC is not an affiliate or subsidiary of PAS or Guardian. CA Insurance Lic. #0F03557 | Guardian and its subsidiaries do not endorse or have any direct or indirect responsibility with respect to this activity | 2015-11504 | exp 10/17
About Ryan Schulte
Ryan Schulte is a financial advisor who focuses his practice on Dentists. He works with young dental professionals that are transitioning in their careers and helps them manage their student loans, understand the insurances they need and how to design them, how to investment money without speculating and gambling, what it means to be an independent contractor and a business owner, understand their tax situations and a variety of other issues unique to dentists. Ryan lives in the mountains near Yosemite with his wife and 5 boys on 4 acres that they affectionately refer to as the “The Schulte Farm.” Ryan serves on a community development council dedicated to redeveloping an industrial zone in Madera County. He also coaches little league and enjoys hiking, brewing beer, playing softball and soccer. His contact info can be found at www.ryanschultecfp.com.