A 401k is a tax-advantaged retirement account sponsored by an employer. The tax implications differ based on whether the 401k plan is a “traditional” plan or a “Roth 401k”. When not otherwise stated, most people refer to traditional 401ks as simply a “401k”, as Roth 401ks are newer and less common.
A traditional 401k allows an employee to save for their retirement using pre-tax money – thereby reducing their taxable income in addition to putting money aside for retirement. The money is taxed when withdrawals are made from the account. Using this type of plan, you are deferring your taxes until retirement.
Once you have a reliable handle on your monthly expenses and income, you should be able to look ahead to your future bills and be aware how much you’ll need to cover them as well as how much you can save or use to pay down debt.
The great next step to take is to start automating your financial life. You should try to set up auto-bill payments on everything you can and set up automatic transfers on savings. You’ll have the peace of mind of knowing that you won’t miss any payments or get charged late fees, and that you can take a vacation or a long weekend and not worry about whether you paid the mortgage or the credit card bill.
OK, we’ve started tracking our finances, got a handle on our expenses, paid down debt, and saved up a cash cushion. What’s next?
The next typical step to take is to begin saving for the long-term and the most efficient way to do that is to use a tax advantaged account like a 401k.
In our last installment we went over paying off emergency debts.
- Credit card debt, personal loans, and any “high interest” debts qualify as emergencies of their own and take priority over trying to build up a cash cushion.
- DO NOT SAVE FOR EMERGENCIES IF YOU ALREADY HAVE CREDIT CARD DEBTS! THEY ARE AN EMERGENCY!!!!
- Generally, mortgages and student loans are the only “good” debts to be comfortable with paying off over the long-term.
Earlier we talked about tracking your finances and budgeting. Today we’ll discuss paying down high interest debt.
Now that you’ve got a handle on your month to month expenses and can start projecting out your cash flow, that will allow you to funnel the savings to increase your net worth (or in this case decrease your net liability) – and let your money work for you.
In our previous installment we discussed tracking your finances to get an accurate picture of your cash flow, expenses, income and investments. This gives us a great starting point for our next step: Budgeting.