This week on the PerkStreet blog, we’re tackling topics to help you steer clear of some financial dangers, from investing in your retirement to co-signing a loan to protecting yourself from fraud. This first post in the series comes to us from Craig Brokowski, the creator of Free from Broke – a personal finance blog for regular folks.
A company sponsored 401(k) can be a powerful retirement investment vehicle. But do you know many employees either choose not to participate or don’t contribute at least to the company match? This could be serious long-term money left on the table for retirement. I’m here to tell you three simple reasons you need to contribute to your 401(k):
1. Company Match
Most 401(k) plans have what is called a “company match.” What this means is your employer will match the amount you contribute in your 401(k), usually up to a certain limit. An example would be an employer match of 50% of your contribution up to 6%. What this means is if you contribute 6% of your salary to your 401(k) your employer will match 50% or half the amount you put in.
Why is this important? The company match is basically FREE MONEY. The company is giving it to you! Using our example, if you invest 6% then you will make a 50% return right off the bat for retirement. And this money gets to earn and grow for your retirement.
Think of it another way – Who hasn’t complained about how much they get paid? If you don’t contribute up to the company match then you are missing out on a bonus your employer is offering up to you.
Suggestion: Consider contributing at least up to the company match to maximize the bonus for retirement.
2. Money Contributed in Gross Dollars
When you contribute to your 401(k), the money taken out is from your gross income. This means it’s taken out pre-tax, lowering your taxable income base (read: you pay less taxes). Let me give you an example: Say you make $50,000 in salary a year. For simplicity’s sake we’ll say you get taxed on that entire amount. Now if you contribute 6% (a typical company match amount) your taxable income drops to $47,000. That’s $3000 you don’t have to pay taxes in right now! (Note: because a 401(k) is pre-tax dollars, you will get taxed on the money when you take it out at retirement. But the money will also have time to grow tax-free.)
Another way to look at it is you get to stretch your investing money further. Say you contribute $100 to your 401(k) and your tax bracket is 25% (I’m using easy numbers for example’s sake). Because the money is taken out pre-tax, it’s really only costing you $75 for a $100 investment. That’s pretty cool.
Recap: Money invested in a 401(k) is pre-tax and will help lower your taxable income.
3. Automatic Investing
Want to know a great way to make sure you always invest? Make it automatic! Automatic investing is an inherent feature of 401(k) plans. Every time you get paid a percentage of your paycheck goes to your 401(k) without you having to do anything. What happens to most people is they say they are going to invest for retirement but after bills and expenses and such there’s nothing left over to invest. The automatic investing feature of a 401(k) makes sure you will always contribute to your retirement.
Here are a few other benefits of automatic 401(k) contributions:
-Many company plans allow you to set up your account to increase the percentage you contribute every year. Year one you contribute 6%, year two 7%, and so on… Before you know it, you are putting in a nice chunk of change towards retirement!
- Since what you contribute is a percentage, when you get a raise, the dollar amount you put in goes up exponentially. As you make more money, the base of your retirement savings goes up.
- Some company plans offer re-balancing. When you set up your plan investments you set up what percentages you want invested in different plan funds. Over time, the overall percentages can get out of whack as certain funds do better. With re-balancing you can keep your investment choices in your desired percentage range. With re-balancing you get to keep your portfolio set up with the asset allocation you originally set up.
Recap: A 401(k) provides automatic investing for your retirement.
So you can see, there are some great reasons why you should be contributing to your 401(k)! If you aren’t putting money into your plan you can be leaving retirement money on the table. If you are contributing, you may not be putting enough in to maximize your company match.
Can you think of other reasons to contribute to a 401(k)?