Why Aren’t You Maxing Out Your 401(k)?
It may be the best retirement planning tool you have.
Do you have a million dollars? At the moment, probably not. But if you invest and save diligently and let your assets compound, who knows? You may be a millionaire someday. In fact, you may need to be a millionaire someday. If you stay retired for twenty or thirty years, it could take well over $1 million to fund that retirement. In fact, Andrés Cardenal, CFA and financial analyst, recommends $1.25 million if you plan to match inflation over a three-decade retirement. This is one reason why you should contribute the maximum to your 401(k) plan.1
Your 401(k) is your friend. For years, employers have wondered: why don’t people contribute more to their 401(k)s? Some people don’t speak “financial” and don’t look at financial magazines or websites. It’s “boring.” So they mentally file “401(k)” under “boring.” But the advantages of a 401(k) should not bore you; they should motivate you.
Tax-deferred growth and compounding. The money in your 401(k) has the potential to compound year after year on a tax-deferred basis. The earlier you start, the more compounding you get. Let’s say you put $2,400 annually in a 401(k) starting at age 30, and for the sake of example, let’s assume you get an 8% annual return. How much money would you have at 65? You would have a retirement nest egg of $437,148 from putting in $200 per month. But if you started putting in that $200 a month five years later, you would have only $285,588. You can put up to $18,000 into a traditional or “safe harbor” 401(k), and if you turn 50 or are older than 50 this year, you can put in an additional $6,000 in “catch-up” contributions. You can contribute up to $12,500 to a SIMPLE 401(k), with “catch-up” contributions of up to $3,000 if you are 50 or older. These annual contribution limits are indexed for inflation. *,2
Potential matching contributions. Who would turn down free money? Big companies will often match an employee’s 401(k) contributions. Usually, the corporate match is 50¢ for each dollar up to 6% of your salary.3
Reducing your taxable income. Many employees don’t recognize this benefit. Your 401(k) contributions are pulled out of your wages before taxes are withheld (pre-tax dollars). So you get reduced taxable income and tax-deferred growth potential; you pay taxes on 401(k) assets when you withdraw them from the plan. With the Roth 401(k), the contributions are after-tax (no reduction in taxable income), but you can enjoy both tax-free compounding and tax-free withdrawals.
Why not take advantage? If you don’t contribute greatly to your 401(k), 403(b), or 457 plan, you are ignoring a great retirement savings and investment opportunity. Talk to your financial advisor about your 401(k) and other great resources to save for retirement.
David T. Larson CLU, CFP®» may be reached at 540-574-4391 or email@example.com.
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Qualified accounts such as 401ks are accounts funded with tax deductible contributions in which any earnings are tax deferred until withdrawn, usually after retirement age. Unless certain criteria are met, IRS penalties and income taxes may apply on any withdrawals taken prior to age 59 1/2. RMDs (required minimum distributions) must generally be taken by the account holder within the year after turning 70 ½ .