401(k) plans are critical to building a financial foundation for your retirement. They let you invest a predetermined portion of each paycheck, prior to your regular payroll taxes being deducted. Those funds remain set aside for you, tax free, until you withdraw them for retirement.
I made sure to sign up my for my company’s 401(k) plan as soon as I started working there, to start putting away money for retirement. Like every other young adult or kid out of college, I never took retirement savings seriously. But after doing some research, I learned the importance of getting a head start on my retirement saving.
401(k)s grow over time
Since 401(k)s are invested, the money will grow through the power of compound interest. Thus, the most important aspect of 401(k) investment is time. The longer you have money invested, the more you will have in retirement. So it’s incredibly important to get started as early as possible.
There are limits, though, to how much you can stash in a tax-free 401(k) account each year. For instance, in 2017, the limit is $18,000 if you’re younger than 50 years old and $24,000 if you’re over 50.
Typically, 401(k) funds aren’t supposed to be withdrawn until your retirement. If you withdraw prior to retirement, there will be stiff penalties. So, it’s considered best practice to never touch 401(k) funds if you can help it.
Employers match contributions
Some employers offer to match your 401(k) contribution. While the percentage of those matching funds vary from employer to employer, there are some who match 100% of your contribution, essentially doubling your dollars. Oftentimes, the amount of an employee contribution increases the longer you stay with a particular company.
Also, if your employer offers a 401(k) match, make sure you contribute enough to take advantage of the match. This is free money that you can’t get back later. Many employers require you to contribute a minimum amount, usually 3% of your pre-tax pay, before they match your contributions.
My employer matches contributions, with the standard 3% minimum. I started the first year contributing 7% to my 401(k), then dropped that number to 3% to focus on paying off my student loans. Once they’re to a manageable level, I’ll be bumping that number up, until I eventually get to 15%+.
401(k)s are smart investments
As you can see, a 401(k) is a smart investment for your retirement. There are a few things you need to know to get the most out of it:
- Your eligibility depends on your employer
- A 401(k) can only be set up by the employer, not the employee
- There are certain contribution limitations, as outlined above
- Your deductions are automatically taken out of your paycheck
- Withdrawing money from your 401(k) account before you reach the age of 59½ will likely result in a penalty of 10%, as well as the taxes you didn’t pay on them
- Your employer may be eligible for certain tax benefits for investment contributions
- Your employer may invest your contribution in up to 24 different investment vehicles
- You can increase or decrease the amount of your contributions at any time
Simply put, a 401(k) plan is a convenient retirement savings plan backed by your employer. It allows you to easily invest a portion of each paycheck before the IRS takes out your regular portion of federal taxes. You’ll never pay taxes on that money until your retirement. It can be a painless way to invest in yourself and your future.