The next time you’re at work or out in public, take a good look around you. You may not realize it but there’s a solid chance that nearly half of the people you see have nothing saved for retirement.
This is according to a survey of over 2,000 respondents by GOBankingRanks. When asked about their savings, just over 45% of them claimed that they had put no money aside for retirement. What’s even more alarming is that 48% of the respondents said they didn’t even care about saving for retirement.
If you’re not already contributing to your employer’s 401k plan, then you could be missing out on a golden opportunity. Investing in your nest egg is one of the easiest ways to make your net worth multiply several times over. In this post, we’ll explain exactly why you should contribute to a 401k plan and how it can bring you closer to financial independence.
Tax-Deferred Savings
Perhaps one of the greatest things about using a 401k is that all of your contributions are tax-deferred. This means that you won’t pay taxes on your savings now. Instead, you get to wait (or defer them) until several years or even decades into the future.
How does this all work? Remember that every time money is taken out of your paycheck and transferred into your 401k, this takes place before taxes are calculated on your earnings. That means you get to skip paying your taxes on these contributions and effectively lower your taxable income with every dollar you save.
Though this might sound like something to get excited over, it actually ends up working out very handsomely for you financially. For instance, if you assume you’re paying about 25 percent in taxes, then by saving your money to a 401k, you get to keep the whole dollar instead of just 75 cents. Now, ramp up your savings to $10,000 this year, and you’ve managed to keep $2,500 out of the hands of Uncle Sam. Smart!
Compounding Returns
Your 401k isn’t just some regular-ole bank account. It’s actually an investment portfolio where you can buy various securities like mutual funds, ETFs, or stocks with your savings.
Although investing might scare the bejesus out of some people, it really is one of the ways to promote the long-term growth of your money. Why is that? Because investing lets you take advantage of the awesome power of compounding returns.
Compounding returns are the money you make on top of the money you invest plus any additional money you’ve earned along the way. Imagine a big pile of money shaped like a triangle that just gets bigger and fatter the more you pour on the top.
In the beginning, compounding returns don’t really seem to be that significant. For example, in your first year of saving $6,000, you might earn 10 percent which works out to an extra $600. Nice, but not exactly ground-breaking.
Now, keep this up for several years in a row, and over time the compounding effects will start to show their benefits. That $6,000 per year will have grown to $986,964 after 30 years of saving. That’s $806,964 more than you contributed! (You can try these numbers yourself using a free online calculator such as this one here.)
And the best part: Your earnings, just like your contributions, are also tax-deferred. All the money that has grown over the years is sheltered from taxes until the day you withdraw it for retirement. Compared to a normal investment account, that’s a big advantage since you’re not paying the IRS every time you decide to trade funds or receive a dividend payment.
Employer Matching
If your boss was walking around the office handing out $100 bills to everyone, you’d probably be willing to throw a few elbows just to get to the front of the line. Yet, so many people forget that when you don’t contribute enough to your 401k (or save anything at all), you’re basically passing up the same opportunity.
401k employer matching is an incentive that the majority of companies in the U.S. have adopted as a way to motivate their employees to actively save for retirement. The process works with the employer kicking in a fixed amount of money for every dollar that the employee saves. It might be 25 cents, 50 cents, or it could even be as generous as dollar for dollar.
These matching contributions are nothing to pass up. Depending on what maximum limit your employer places on these contributions, it can significantly increase the amount of money you’re socking away for retirement each year. That’s just even more money that can get invested and compounded for decades while you work towards your retirement date.
If that wasn’t reason enough, then you might also be interested to know that these employer matching contributions are tax-deferred. So just like the money you’re saving, you won’t pay anything to the IRS on these extra funds until they’re eventually withdrawn someday.
Automated Contributions
If you’ve ever found that saving your money is difficult, you’re not alone. Mentally, it’s just as difficult to manually put a portion of your paycheck aside as it is to pay your bills (like your credit card or utilities).
This is where utilizing your 401k plan can help. Since the contributions are made automatically and before you ever see your paycheck, you barely even know that it’s happening. Everything will occur behind the scenes and will take all of the emotion (or distress) out of saving. As the old saying goes: Out of sight, out of mind.
Bonus Opportunities
If you work at a place that pays you an annual bonus or even profit sharing, then you might find that having a 401k plan can make this an even better opportunity.
Not a lot of people know this, but as of 2021, employers are actually allowed to stick as much as $58,000 into your 401k plan (minus anything you’ve contributed). That means there’s an opportunity to go beyond the normal $19,500 that you can individually save.
I worked for a company that did this as part of its profit-sharing program and it was an outstanding hidden gem. Not only would they pay you a nice bonus, but they’d also put a hefty sum of money into your 401k plan too. That really accelerated my savings rate and helped grow my 401k far more than I could have ever imagined.
It All Starts with Retirement Planning
As you can see, there are a lot of reasons why you should contribute to your 401k plan. Not only can you avoid paying taxes and get free money from your employer, but you’ll also position your savings to grow and compound for years of optimal growth.
However, none of this is possible until you start the process of retirement planning. If you’d like to get started and see how much your savings could eventually be worth, then let Buxfer help. Buxfer provides you with one convenient place to monitor your retirement savings and then forecast its balance in the future. Find out more about the Buxfer Plans feature here.
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