- What is a 401k plan?
- A retirement savings plan sponsored by an employer. It lets you save and invest a piece of your paycheck before taxes are taken out. In addition, most employers offer a ‘matching contribution’ which means they will match any employee contributions up to a cap at some percentage of the employee’s compensation. Taxes aren’t paid until the money is withdrawn from the account.
Why is it important you start contributing towards your 401K starting in your 20s?
- The reason you should start contributing, if not maxing out, your 401k starting in your 20s is due to the power of compounding growth. Compounding means that you keep earning interest or growth on the interest or growth you’ve already earned. For example, if you have $2,000 in your 401(k) account and it grows by 8 percent, you end up with $2,160 by the end of the year. If you just got 8 percent on the same $2,000 in the second year, you’d get another $160, giving you $2,320. However, if your account compounds, the entire $2,160 would grow at 8 percent, leaving you with $2,332.80. That extra $12.80 might not seem like a lot, but it adds up quickly. At 8 percent non-compounded, your money doubles in 12.5 years. With yearly compounding, it doubles after nine years. The example comes from the website MoneyChimp.com. Your frenemy is time. Do not stop contributing to this account so you can manage inherent foundations of the stock market. For example, during recessions, you will be able to purchase stocks/mutual funds at cheap values.
- Your investment returns are not taxed (until you start withdrawing).
- 401(k)s help you reduce your tax bill. Every dollar you invest in your 401(k) is a dollar that you don’t have to pay taxes on. If you’re single and make $75,000 per year, contributing $10,000 to your 401(k) saves you $2,500 in taxes. Contribute the maximum $18,000 and you’ve saved $4,500. And that is just for one year! Think of the money you’ll save over decades. If you are in the 25% bracket or above, contribute the maximum. You may even make it to a lower bracket depending on your income.
- Your employer is giving you free money. Ensure you are, at the very minimum, matching your employers contribution. It is free money!!
- Signing up and maintaining the account is easy and low effort.
- Do it while you are growing your career and making the most money. They say women’s pay peaks at age 39, and at age 48 for men.
- There may be no social security when we are 65 and pensions are not an option for our generation. This is one of the few options we have.
Consequences of our decision not to start earlier:
- At the tender age of 28, I should have had well over $119,000 in my 401k plan assuming I would have maxed out my 401k since age 21. I am not including any employer contribution or making any assumptions on markets returns. That was my mistake. That’s money I now must work twice as hard to get and it will take me a couple more years.
- To put things in perspective “someone who puts $4,000 a year into retirement accounts starting at 22 can have $1 million by age 62, assuming 8% average annual returns. Wait 10 years to start contributing, and you’d have to put in more than twice as much – $8,800 a year – to reach the same goal.” – Liz Weston. Enough said.
Our challenge to you:
- Go to the Forbes website and identify your tax bracket. If you are in the 25% or above bracket, contribute the maximum. If you can’t do this, at the very minimum match the maximum contribution your employer has for the plan – this applies to everyone regardless of tax bracket. Time is of essence. Do not delay. Go to your retirement plan website and get this done. You’ll thank me later