You know that you should save for retirement, but getting started is hard. Even the first step -- picking the right type of account -- can feel complicated. There are different investment vehicles that you can choose from, and you may not know which one is best for you.
They all have benefits, and doing something rather than nothing is always good. But if you have access to a 401(k), it's the best tool for reaching your retirement goals for these five reasons.
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1. High contribution amounts
You can contribute up to $19,500 into your 401k plan each year, which is a lot higher than the $6,000 you can add to an IRA annually. If you're over the age of 50, the IRS lets you contribute an additional $6,500 each year. This is especially helpful if you started saving for retirement later in life.
These extra savings can add up over time. If you can contribute $6,500 earning 8% each year to an IRA for 20 years, your account will grow to nearly $297,000. If, instead, you have access to a 401k and contribute $19,500 every year earning 8% for 20 years, your account will grow to almost $964,000.
Historically, the IRS increases contribution limits over time, which would change these numbers a bit if that trend continues. But as long as you can contribute more to a 401(k) than an IRA, you can accumulate more in the long run.
2. Company match
Not all businesses offer a match, but those that do add a percentage of your contributions to your 401(k) up to a certain amount. That gives you even more money toward helping your accounts grow each year.
The match that your company provides isn't completely free of limitations, however. Most companies have a vesting period, which means that you must wait a while before the money is actually yours. Once your match vests, it belongs to you, regardless whether you continue working for your employer or not. If you leave before it vests, though, you'll lose all or part of it.
3. Tax-deferred growth
When you put money into a taxable account, you pay taxes on any distributions, like dividends and capital gains, that are made. You also owe money on the gains of any investments that you sell at a higher price than you bought them at. If you own funds in your 401(k) that pay out distributions, you don't have immediate tax liability. You also won't owe taxes immediately on sales of assets inside the account, even if you have a big gain.
Getting to defer taxes on your money makes it grow even more. This tax-deferred growth also makes your 401(k) a great place for holding investments that pay out a high amount of dividends or other investment income.
4. Reduces taxable income
Your 401(k) gives you more bang for your buck by reducing your taxable income. If you contribute to a regular savings account, you're doing so with after-tax dollars. When you add money to your traditional 401(k), it's being taken out of your paycheck before you pay taxes, and the amount that you contribute doesn't get taxed.
That can save you thousands at tax time. For instance, if you contribute the $19,500 maximum and are in the 24% tax bracket, then your taxes could go down by nearly $4,700.
You'll eventually owe taxes on your regular 401(k) savings -- but not until you start taking distributions. If you're like many Americans, the amount of money you make in retirement will be a lot lower than it was when you were working. Because of this, you'll end up paying taxes off of a lower level of income and potentially get a tax break through a lower rate.
5. Dollar-cost averaging
Predicting the perfect time when you should start investing can make you second-guess yourself. Hesitant that you'll buy in at the wrong time, you may find yourself waiting for longer than you planned -- or doing nothing at all.
Most 401(k) participants use dollar-cost averaging without even realizing it. With dollar-cost averaging, you purchase a set amount of an investment periodically throughout the year. In the case of your 401(k), that will be every pay period. There will be some months where you buy into a particular fund at a high and some months when you buy that fund at a low. But most importantly, your money will get invested instead of remaining in cash, earning very little.
Saving when you're young gives you the best chance of meeting your retirement goals. If you've put off this goal because it seems daunting or overwhelming, your 401(k) can help you get started. Besides providing you with numerous benefits, it's convenient and easy, making it the perfect investment vehicle for you.
