What is a 401(k), Anyway?
It is a type of retirement plan offered through your workplace. They can offer tax advantages. In some plans, your contribution comes out of your paycheck before income taxes are deducted, which means your tax bill will be lower. You could also save on taxes when you withdraw the money because you may be in a lower tax bracket in retirement.
It’s a long-term personal plan for growing your savings by investing in a mix of mutual funds, stocks, and bonds.
The earlier you start saving, the more time your money has to grow.
Automate your savings. Setting up automatic contributions each month and automatically increasing your contributions by 1% or more each year (if your plan allows) are great ways to save, since the money goes directly to your retirement account.
If you’re 50 or older, catch up on your contributions. Saving later in life can still pay off. You may be able to contribute an additional amount each year, depending on the plan you’re in.
One final note: If you’re a high-income earner and already reaching the contribution limit, avoid maxing out early. Find out how your employer contributes to your account and spread out your deferral so you don’t miss out on employer contributions.
You can see the effects of saving early.
Here’s how time and compounding impact a $5,000 pretax yearly contribution when saving starts at various ages.
This hypothetical example assumes the following: (1) $5,000 annual contributions on January 1 of each year for the age ranges shown, (2) an annual rate of return of 7%, and (3) no taxes on any earnings within the qualified retirement plan. The ending values do not reflect taxes, fees, or inflation. If they did, amounts would be lower. Earnings and pre-tax contributions from qualified retirement plans are subject to taxes when withdrawn. Qualified retirement plan distributions before age 59½ may also be subjected to a 10% penalty. Systematic investing does not ensure a profit and does not protect against loss in a declining market. This example is for illustrative purposes only and does not represent the performance of any security.