Do you know who should contribute to a 401(k)? The simple answer is everyone—regardless of age. Think of it this way, if you don’t plan for your retirement, who will?
For some of us, retirement seems a very long way off. In fact, it is almost unimaginable. However, with the average life expectancy increasing and the long-term durability of Social Security in question, you can’t start planning and saving for retirement soon enough. This is where a 401(k) plan comes into play. It is one of the most popular means available today to help you save for retirement.
A 401(k) plan is an employer-sponsored retirement plan that is comprised of an array of stocks, bonds, money market accounts, and other investment options. Each investment option has its own level of risk and rate of return. But most importantly, you get to choose the investment(s) that you believe will work best for your financial goals and future plans. Additionally, you can adjust your investment choices periodically as your goals and plans change. You also decide how much of your income you would like to invest. In essence, it is a great savings vehicle that offers many financial benefits you won’t find anywhere else.
One of the key benefits of a 401(k) plan is that you are funding your retirement plan with “pretax” dollars—meaning your total contributions are deducted from your paycheck before taxes are assessed. This reduces your taxable income. In fact, some of your income that would otherwise be earmarked for taxes is now being saved and invested. When you do eventually withdraw money from the plan during retirement, the hope is you’ll be in a lower tax bracket resulting in fewer taxes paid. At this time, you may even qualify for a partial tax credit.
Furthermore, money held in a 401(k) plan grows tax-deferred. This means that any earnings attained
during the life of your plan are not taxed as long as they remain untouched. Only when you withdraw those earnings will you pay taxes. Meanwhile, tax-deferred growth gives you the opportunity to build substantial retirement funds over the long term. This of course is also dependent upon the performance of your investments.
In addition to tax breaks, there is the 401(k) contribution match that some employers offer. Although plans differ from employer to employer, you don’t want to miss out on this benefit! To ignore this means missing out on free money you are being offered as part of your overall benefits package. An example of this might be where an employer will match 50 cents per dollar contributed up to 6% of your total salary. Some employers don’t offer a matching option or, have a vesting schedule that will determine how much of their match you are entitled to over a certain period of time. However, the latter is never a good reason not to take advantage of this popular retirement savings plan.
If the pre-tax and matching benefits aren’t reason enough to enroll, another advantage that many 401(k) plans offer is the ability to borrow against your vested balance. Assuming you pay back a short-term loan on schedule and don’t violate the loan limits and repayment rules, this practice will usually have little impact on your long-term retirement savings. Reasons for borrowing against your 401(k) will vary. But paying off debt may make sense for some depending upon their overall financial condition and goals.
So remember, you are never too young to get started—the sooner the better!
For more information about 401(k) plans, click here.