Finance topics are to the masses as spiders are to arachnophobia. We just want to stay away from finance. Mainly because it’s too confusing and usually finance stuff is for grown ups… and none of us want to grow up! (I understand!)
Trying to simplify finance is similar to explaining art… because they are both abstract.
With this, I went to the drawing board and tried to draw out a finance topic relevant to many of us… the 401k.
After looking at my drawing, I realized how abstract art really is (and also why I am not an artist, and how much credit should be given to artists).
How I determined to explain a 401k will show just how abstract my drawing was, or maybe just how bad I misinterpreted my own piece of art. (At the bottom of this piece you will see my art come to life!)
Blowing up our savings
A lot can be learned from blowing up a balloon. We can learn a lot about a 401K when we take a look at the process of blowing up and ultimately deflating a balloon.
A balloon is filled with air, while a 401K is filled with mutual funds. To me, air and the makeup of the molecules is difficult to understand… I was awful in chemistry. Mutual funds can be just as difficult to understand to some, but these are what fill up a 401k.
They are investments that help the 401k grow. Check out this infographic on another investment, an ETF, which is very similar to a mutual fund.
If we were to just take one deep breath and try to fill up a balloon, we would be limited to how big the balloon would get. But if we got more people to provide one big breath, we could get an even bigger balloon.
The same can be true for a 401K. We are limited to the amount we can contribute each year, but we can get some additional money added by our employer. This helps our 401K get bigger, faster!
Deflating the balloon
It’s time for retirement. Blowing up the balloon has worn us out, so we stop; this is the same as retiring from the job we love.
Here is the catch.
We must live off the air from the balloon for the rest of our life.
We now have two options: pop the balloon and get all the air out at once, or pierce the balloon and take a little air out over a longer period of time.
When you pop the balloon you will capture the most air, but we will also lose a lot of air during the process. The air that is captured from the balloon must now be used for the rest of our life… ouch! The lost air really hurts us.
Needing money from a 401k is similar. We can take all of it out at once (we have to be 59.5 in order to not incur penalties). But one caveat… just like we were hurt with a lot of lost air in the balloon, we will be hurt with having to pay taxes on the entire amount! This will drastically decrease the amount that we have the ability to utilize for the rest of our life… not the best option.
Option two would be to pierce the balloon. Take small amounts of air out every year and then reseal (work with me here) the balloon.
With a 401k, we can do this and spread out the tax consequences, while letting the money stay within the 401k (which is tax advantageous). We can just take out what we need to live off of every year.
Don’t be a whippersnapper
I’ve experienced it multiple times and it sucks.
I am getting close to finishing blowing up a balloon and someone thinks it will be funny to pop your progress. I had come so far and to see it all pop in front of my eyes by a little whippersnapper is the worst!
Well, with a 401K we have the opportunity to be our own whippersnapper.
The money within a 401K can be taken out before 59.5… WAHOO! Hold on for one second. It comes at a cost. You must pay taxes on the entire amount and then also pay a 10% penalty.
By being foolish and looking to utilize the 401k (retirement funds) for current needs, you become that obnoxious whippersnapper. Young you will make old you very mad.
Don’t be the whippersnapper!
Oh, and about that image I drew… here it is