Today, saving for retirement largely falls on you. Previous generations could work a job until they retired and enjoy a pension covering most of their living expenses. Today, the pension is essentially extinct.
Instead, there's the 401(k) retirement plan, an employer-sponsored personal investment account that workers fund with their wages. Unfortunately, about one-third of eligible workers don't participate, putting them behind in building a healthy financial future.
Here are three reasons you absolutely must fund your 401(k) plan.
1. You're probably missing out on free money
About 8 in 10 employers will help you put money into your 401(k) with a company match, where employers will match your contributions with their own funds. How much they will match ranges across companies.
Some will match dollar for dollar, while some will match $0.50 for every dollar you contribute, up to a certain amount (up to about 4.5% of your salary on average).
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Suppose you make $50,000 a year; you contribute 3% of your salary ($1,500), and your employer matches that, dollar for dollar. Your $1,500 is matched by another $1,500, making your total contribution $3,000. The company match doubled your initial contribution without any investment returns from the market yet! It's as close to free money as you get.
You can contribute a maximum of $20,500 to your 401(k) plan each year as of 2022. Many people will have a hard time approaching this limit, but it's beneficial to your financial future if you can at least put enough money to collect the most your employer will match.
2. You'll pay less in taxes
The U.S. government also wants you to save for retirement; assuming your employer 401(k) is a traditional plan, your contributions are pre-tax dollars.
Let's go back to that hypothetical $50,000 salary. If you contribute 10% of your salary to your traditional 401(k), that would reduce the salary that the government taxes down to $45,000. The more you contribute, the lower your taxable income will be for that year.
The catch is that you pay taxes later when you withdraw the funds from your 401(k). Those with different plans like a Roth 401(k) might fund them with take-home pay -- what's left after income tax -- but they can pull the money out tax-free later in life.
It's essential to know the difference, so consult your employer about your specific plan.
3. Out of sight, out of mind
Each type of 401(k) can have different rules, but helping you build a healthy retirement nest egg is the common thread linking them. The best benefit of employer-sponsored retirement plans is arguably one you might not even realize you're getting.
Retirement plans all have safeguards, like early withdrawal penalties, to keep you focused on the long term. Unfortunately, investors can sometimes be their own worst enemies, and it can be tempting to cash in on your growing nest egg to buy that new car you've been eyeing.
Your 401(k) and other retirement plans work in the background, and that's by design. The contributions are typically automatic, and you don't even see the money leave your paycheck; it stays out of sight and out of mind, which is good for most investors.
