Your 401(k) – Are You Taking Advantage?

by admin on June 2, 2011

Most employees have some sort of retirement savings plan set up at their place of employment.  If you have one, I hope you are taking advantage of it.  If you aren’t, there are some compelling reasons why you should.

Tax Advantages

First of all, you will save on your tax bill since 401(k) contributions are not considered taxable income.  You will have to pay taxes eventually when you use the funds, but most people are in a lower tax bracket at that time, and meanwhile your earnings can compound and multiply without having a bite taken out by taxes on the gains.

Matching Funds

Another good reason, if it is offered, is matching funds.  Many employers will offer matching funds for 401(k) contributions.  These are usually limited.  For example, your company may offer a 50% match up to $5,000.  This means that for every dollar you put in, your company will contribute fifty cents.  If you contribute the full $5,000 in a calendar year, your employer will kick in another $2500.  It’s like free money.  Oh wait, it IS free money.

Pay Yourself First

Many people say that they can’t afford to contribute because by the time they pay all of their expenses, there is not enough money left over.  I am a proponent of paying yourself first.  If you pay yourself last, you usually end up not paying yourself at all.  If you had an actual bill would you pay it?  Yes?  Then I encourage you to place as much importance on your future as you do your other bills.  At least.

How do you figure out how to invest your funds?

Most 401(k) funds have different investment options.  For instance, your company might offer a S&P fund, an international fund, a growth fund and a money market fund.  These all come with different levels of risk.  The lower the risk, the more stable the return will be.  With higher risk funds, you have more of a chance of bigger gains, but there is also a bigger chance of losing money.  Conventional wisdom is that the longer you have until you need the money, the higher risk you can afford to take, since over longer periods of time, possible losses are more likely to be accompanied by periods of high returns.  You can get in trouble by trying to time the market fluctuations.  If you are close to retirement, you are probably better served by sticking to lower risk choices.

Do your homework on the different options available.  Read the materials provided, ask the opinion of someone with investment savvy, and make your best picks.

Start Early

The numbers are staggering.  Let’s say you want to retire with a nest egg of $500,000.  And let’s also say that the average return on your investment is 5%.  Finally, let’s target age 65 as your retirement target.  Given these assumptions, if you start at age 25, the annual contribution required to reach that goal is $4,139.  If you start at age 35, that figure jumps to $7,525, and if you wait until age 45 you will need to contribute a whopping $15,121 per year.  At age 55 you would need to contribute nearly $40,000 per year.  Here is a handy calculator you can use to run some of your own scenarios.

Remember, the most important choice is not which fund you choose.  It is the choice to invest in yourself.

 

 

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