I am getting older. You are getting older too. The day when you will want to quit working and retire is coming faster than you think. By the way, how do you plan to pay for your living expenses in retirement?
Most financial planners recommend having 60-70% of your pre-retirement income to have a comfortable living in retirement. So where is your money will come from? Your employer-sponsored 401k plan can be a great source.
Let`s discuss six reasons you should join a 401k plan.
1. The convenience of an automatic investment
When it comes to 401k plan, the system is designed to your favor. To contribute you do need to write a monthly check, call your broker or do anything else. Actually, you do not need to do anything because your employer will automatically deduct your contribution directly from your paycheck each pay period. Done!
I love automatic investments of the 401k plan because I am a busy mom of three kids and I have thousands of things on my mind in any given moment. I also see 401k as a self-care opportunity. When I pay myself first, it is impossible to spend the money you don`t have in your checking account. After a while, you forget it even happens, but on the background, your 401k contributions continue to happen every two weeks, and your retirement nest egg continues to grow. It is magic!
2. Matching employer contributions
If your employer offers 401k Matching, you simply must participate in the plan. There are excuses, buts or maybes. Your employer gives away free money; your job is to take it. End of story. All you need to do is to find out what is the 401k percentage is and at the very minimum contribute that percentage.
Scenario example: let’s say you make $50,000 as an annual salary and your employer matches 50 percent of your contributions up to 6 percent of your salary. This means you will need to contribute 3,000 annually and your employer, in turn, will contribute $1,500 of free money directly to your 401k retirement plan.
Long story short, If you are not taking advantage of this perk, you toss money away.
3. Tax breaks
Tax advantages of 401k plans are twofold.
First, you pre-tax 401k plan contributions are tax-deductible, which means you will pay fewer income taxes at the end of the year. This can mean thousands of dollars in savings for dual income families.
For example, a few years ago, I landed some consulting gigs, and my spouse had his regular job. By mid-year we realized we need to mitigate our tax liability, so we decided to increase my spouse`s 401k contribution percentage to a maximum.
That year our family was in 25% tax bracket, and therefore our tax savings on the contributed amount was 18,500 x 25% = 4,625 dollars. As a result of the decision, my spouse ended up with a healthier looking 401k balance, and we saved on taxes.
Secondly, your 401k nest egg grows significantly faster in a tax-deferred account versus in fully taxed one. In 401k all your earnings get deposited back to your portfolio, and your taxes are deferred until you take money out in retirement.
4. High annual contribution limit
Employer-sponsored, defined-contribution plans or 401k has a much higher annual contribution limit than other retirement plans. According to Internal Revenue Service 401k contribution limit is $19,000, and IRA contribution limit is only $6,000 in 2019 (Credit: IRS.gov) Furthermore if you are 50 and over you can contribute an additional $1,000 as a catch-up contribution.
If you decided to get serious about saving for your retirement and want to contribute a significant amount annually, a 401K plan is a way to do it!
5. Dollar cost averaging
One thing I love the most about contributing set percentage of your pay to your 401k plan portfolio is the dollar cost averaging. This is how it works when stocks/mutual funds become more expensive you automatically buy fewer shares with your money. If market drops and things get cheap, you buy more!
Example, I contrite $200 every month to my 401K plan and I buy mutual fund XYZ. In January one share of the fund costs $50, how many shares would I own? $200/$50 = 4 shares of the mutual fund. If the market drops in October and now one share costs $30, now with my contribution I will get $200/$30 = 6.7 shares of the same mutual fund. It is an easy way to save a bundle and take advantage of the market fluctuations.
6. No minimal initial investment limits
Another amazing feature of 401k plans is there is no minimum amount you need to start with. You can start saving with as little money as you have!
In contrast, if you want to contribute to your retirement by opening a Vanguard self-directed IRA, you better have a minimum of $3,000 of initial investment for most funds. With 401k you do not need to worry about minimums at all!
By now you probably could tell I am a big fan of 401k plans. In fact, after being self-employed for nearly five years and running my own companies, I consider becoming an employee again, in part because I want to be eligible for the 401k plan and take advantage of employer matching!
You too can start planning for your retirement and take advantage of all the benefits 401k plans have to offers, such as convenience of automatic investments, matching employer contributions, tax-deferral, high maximum contribution limits, dollar cost averaging, and no initial minimum investment!
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Questions to my readers:
- What about you? Out of six benefits of joining 401k plan which one matters to you the most?
- Share your 401k plan learning experiences and wins?