If you’re employed with a company that offers a 401(k) plan and you are not participating, reconsider! Consistently contributing to a 401(k) throughout your working years can help create a secure retirement.
It’s not as difficult as you think: Let’s say you’re starting now at age 25 and your annual salary is $50,000. If you contribute ten percent of your earnings consistently, receive a three percent raise each year and earn an eight percent rate of return on your investment, you could have more than $2 million in your 401(k) by the time you retire at 65!1
Depending on your employer’s tax status, your plan may be called 403(b) or 457. Both are similar to a 401(k) in how they benefit you.
There are other financial tools available you can use to prepare for retirement, but 401(k)s offer many advantages that other savings and investment vehicles don’t. Here are three of them.
1. 401(k) contributions are “before tax” money
The amount you choose to contribute to your 401(k) is deducted from your paycheck before taxes are taken out. As a result, you’re paying taxes on a smaller portion of your salary and your overall tax rate may be lower.
Be aware there are limits to how much you can contribute to your 401(k) in any given year. Check the contribution limit periodically, as it can change every few years.
2. When you finally pay taxes on your 401(k), it may be at a lower rate
Your 401(k) savings is tax-deferred, not tax-free — you will be taxed on the amounts you withdraw in retirement. But many people find their tax rate drops when they enter retirement, so you could end up paying less tax on your savings in the end.
3. Your employer may contribute to your retirement plan
Many employers offer what is called a “matching contribution.” That means they will match the dollars you contribute to your 401(k), usually up to a certain amount.
For instance, if your employer offers a 5-percent match, it means they will contribute the same amount to your account that you do, up to 5 percent of your salary. (You may be able to contribute more, but only the first 5 percent will be matched.)
In other words, your employer is offering you extra money. Think of it as additional salary. Or a bonus. Now ask yourself — if you’re not contributing to your 401(k) — why are you leaving that money on the table?
A couple of things to remember
You own the money you contribute to your 401(k) – so if you change employers, you can roll it over into your new employer’s 401(k) or another qualifying retirement plan account.
Keep in mind that your 401(k) plan operates on the assumption that you are saving for retirement – so once you’ve put dollars in, there are penalties if you decide to take them out before you reach retirement age.
To withdraw the money means you also miss out on the advantage of time and its effect on compound interest.
Saving early and increasing your contributions as you go can help set yourself up for a secure retirement.