newbie investment questions

[yams]

hi all!

i am currently a 22 year old undergraduate senior at the university of washington, and am just getting out into the world of money. my double majors are in the realm of science, so i really have not had much exposure to how money works. i've only read robert kiyosaki's book on debt-investments-turned-to-riches, but i have my own reservations about that type of risk. i hope my newbie questions will be answered quickly without too much embarrassment! moderators, please move this thread if it's in the wrong subforum!

firstly, i would like to ask about the difference in retirement plans. what is the difference of investing in an independent retirement 401(k)/roth-IRA/IRA like vanguard, versus investing in your own employer's retirement plans? i understand that you can choose to contribute to all 3 if you wish, but i don't understand what the difference is between independent versus employer plans.

secondly, as an undergrad graduate this spring, i have a job lined up that pays approximately $3,500 salary. how should i start my investments, and where would i go to do this?

lastly, can anyone recommend any good starter books for investments for young persons like myself?

any help would be GREATLY appreciated, thank you all!

[jIM_Ohio]

I will answer your first general question with an example.

Assume a single person making 100k.
6.2% for fica (social security)=$6200
1.1% for medicare=$1100
100k is in middle of 28% federal tax bracket (taxes owed would be $21978
The net tax home would be 100k-6.2-1.1-21.978=70722. This is before state taxes are taken out. In Ohio the state tax on 100k is 5.943%.
5943 Ohio taxes take out would be $64799 in net take home pay. No money was invested.

If same person used a 401k and chose to put in 15%, here are their numbers:

100k, $15000 invested, $85k taxable.
FICA is 6.2% of the 85k=$6200
medicare is 1.1% of the 100k ($1100)
federal taxes (85k is in 28% federal bracket)=$17,778 taxes owed (more than $4000 saved from above).
Net take home is 100-15-6.2-1.1-17.778=$59582 ($7000 less than above). State taxes would be $5052 ($900 less than above) for a net take home of $54,530.

In summary- second example had $10,000 less in take home, but invested 15k into the 401k before taxes were applied. More money is working for individual and less is being taxed.

401k- is a workplace retirement plan. The yearly max is $15,500 for employee contributions. Often employers match around 2-5% of this. For example my employer matches 2/3 of every dollar up to 6% (I put in 6%, they put in 4%, I put in 11%, they put in 4%). So more than just the $15000 is invested ($15000 is the employee contribution).
A traditional IRA works the same way except:
1) the max is $5000 per year
2) You need to claim the adjustment for the 5k on your tax return (401k adjustment is each paycheck). The end result is the same when netted on tax return.

Your company chooses the investments in the 401k and you choose the investments in an IRA. You might be able to use 401k and deduct the IRA, but at 100k, that is not an option.

A ROTH account is similar to first example. You pay ALL your taxes up front (SS, federal, state) and then investments are not taxed on withdraw.

The 401k and regular IRA will owe federal and state taxes on withdraw. SS and medicare are not income taxes, so those taxes will not be paid on IRA or 401k withdraws.

[jIM_Ohio]

For your second question- is the $3500 monthly, yearly or other? How often are you paid that wage?

Assumption- I assume $3500/month (42k per year).

The best plan would be
a) contribute 15% of the salary to 401k or traditional IRA (25% tax deduction is too good to pass up). 15% is $6300 year. 401k is OK, IRA would need $1300 invested in a taxable account ($5000 max for IRA plus $1300 more in taxable account).
b) set aside 5% of salary in a savings account ($2100/year).
c) live on the rest (know that 8k of your income is being set aside)

If you make $42k and learn to live on $34k, you will be able to create considerable wealth without borrowing a dime.

[yams]

jim, thank you a lot for all your information! it has helped to reinforce some concepts, i've talked to a few "older" folks here and each time they explain their view it has helped beat it into my brain. my $3500 is per month, so your assumption is correct. your breakdown/advice also follows that of the other advice i've been getting. i do have a few more questions though.

so as i understand, the purpose of a company like vanguard is that instead of your employer choosing your retirement fund investments, you can choose your own investments? i think i am missing some information.

when you invest your retirement funds, does that mean putting it into the stock market, such as through mutual funds?

again, thank you for all your help, it will be invaluable to me for a lifetime.

[jIM_Ohio]

If you do the 15%/5% I suggested (15% to retirement and 5% to savings), then what you asked is almost correct.

15% in retirement would be in the stock market unless you chose something different (like bonds, money markets, gold or silver).

Yes you could do an IRA with vanguard, or a 401k plan with your employer. The 401k will be cheaper fee wise. You save the 6.2% on SS taxes the IRA does not get you, and you avoid the investment fees vanguard will charge you until your account hits around 10k.

Vanguard has mutual funds with low expense ratios, but just because vanguard charges .15% expenses and a 401k fund changes .75% does not immediately make one decision bad. Vanguard investors can be like a cult and I avoid discussing specific fund selections with die hard vanguard investors. That will be like debating roe v wade, obama vs mccain or boxers vs briefs.

disclaimer- I am on 401k plan #4.
401k #1 was with T Rowe Price
401k #2 and #3 were with Vanguard
401k #4 is private and my expenses are lower than vanguards (we have institutional funds because my employer is so large).
Not all 401ks are bad. Depends on your employer. I would not make decision of IRA vs 401k until you saw the detailed plan your employer offered. My wife's 401k is with fidelity and their funds are also cheaper than vanguards.