At Simply Money Advisors, we often discuss the pros and cons of a 401(k) plan. While we believe a 401(k) plan may not be the best investment vehicle, it is the most common way people save for retirement, so you should take full advantage. Here are a few benefits to participating in your employer’s 401(k) plan.
If you were taking an evening stroll and you looked down to see a $100 bill at your feet, would you pick it up?
Many people wouldn’t pass up the opportunity for free money. Would you be surprised to learn that many working Americans – as many as 1 in 4, according to a recent study – are leaving thousands of dollars on the table by not participating in their employer’s match program?
Don’t let this be you.
Your employer’s 401(k) match is free money that can help you achieve your financial goals. It can be hard enough saving for your future, so let your employer help!
Every employer establishes their program in a different way. They could require you to put 6% of your salary in the 401(k) and then they’ll match 3%, for example. There are plenty of different ways your employer can set up their plan, so meet with your Human Resources department to understand your company’s plan. Don’t ever leave free money on the table.
The ‘Roth’ option
About 50% of large companies offer a version of the 401(k), called a ‘Roth’ 401(k). What’s the difference? With a traditional 401(k), you contribute money before you pay taxes on it. While this lowers your taxable income in the short term, you eventually do have to pay taxes on withdrawals in retirement.
With a Roth 401(k), you contribute money after you pay taxes on it (so no tax break in the short term), but then your money grows tax free.
Let’s repeat that: tax-free growth! How cool is that?
If your employer offers a Roth 401(k), consider utilizing it. It’s a great way to give your money some flexibility in the future.
A long ‘time horizon’
When you’re saving in a 401(k), the money you’re contributing is, in theory, getting earmarked for retirement – which is probably decades from now. That means compounding is about to take over.
Simply Money Advisors believes that compounding is magic. Basically, as Ben Franklin said: Money makes money… and the money money makes makes more money (try saying that 10 times fast!).
Take this, for example: say you contribute $100 every month to your 401(k) for 30 years, and assume you get a 7% return each year. You’d have close to $122,000 after 30 years. If you put $100 every month into a savings account at today’s low interest rates (assuming 1%), you would only have about $42,000 after 30 years.
But compounding only works if you don’t touch the money!
So, while your 401(k) plan may allow for you to take out loans or early withdrawals, resist the temptation. Not only will you have to pay taxes and/or penalties, but you’ll also lose all the compounding ‘momentum’ your earnings have built up. Plus, once you take money out, it’s hard to catch back up.
Remember, your 401(k) is for retirement. Whatever you contribute, leave the money be. You want it around decades from now.
The Simply Money Point
Your 401(k) can be a great tool to help you reach your financial goals. If your employer has a plan, make sure you’re doing everything you can to participate.
To see if you’re on track for retirement, we invite you to download our free Simply Money Advisors Guide, ‘How to Prepare for Retirement.’