It's estimated that over 40% of Americans don't have access to an employer-sponsored 401(k), but even those who do get the option to participate in a 401(k) often pass it up. If you're lucky enough to have an employer that offers a plan, the sooner you start taking advantage, the more opportunity you'll have to grow your nest egg into something huge. Here are three ways to make the most of your 401(k) plan this year.
1. Contribute your raise
A big reason many people don't save for retirement is that they can't afford to part with a portion of their income up front. But even if you started off the year living paycheck to paycheck, if you've recently gotten a raise, don't spend that extra money. Rather, arrange to have it go into your 401(k) automatically so that you're not tempted to blow it elsewhere.
Workers under 50 are currently allowed to contribute up to $18,000 a year to a 401(k), while those aged 50 and older can contribute up to $24,000. Now most of us can't reach those limits. Many of us can't even come close. However, you should ideally aim to save at least 10% of each paycheck for the future, and if that's not in the cards right now, start off by saving that raise and work on freeing up more money in your budget over time.
2. Take full advantage of your employer match
A good 92% of companies that sponsor 401(k) plans also offer some sort of matching incentive for employees to contribute. Yet 25% of workers don't kick in enough money of their own to take advantage of their employers' generosity. The result? We're leaving a staggering $24 billion on the table every year in unclaimed matching dollars, which equates to $1,336 per year, per individual.
But while passing up $1,336 every year is imprudent in its own right, you're actually missing out on more than just that initial employer contribution; you're also missing out on the opportunity to grow that money into something more. Thanks to the beauty of compounding, every dollar you contribute to a 401(k) gets to earn you even more money over time. So if you were to contribute enough to get your hands on an extra $1,336 each year, invest it, and generate an average annual return of 8% (which is more than doable with stocks), after 30 years, you'd have an extra $151,000 in your 401(k) courtesy of your employer. If that sounds like too much money to pass up, push yourself to contribute enough to snag that employer match in its entirety.
3. Avoid high-fee investments
Over 90% of Americans with 401(k)s have no idea how much money they're losing each year to fees. The Center for American Progress estimates that the average worker who starts off earning a median salary at age 25 will lose a total of $138,336 in lifetime 401(k) fees. And while certain fees (like those associated with maintaining your plan) may be unavoidable, you can limit your losses by choosing lower-cost investments.
Index funds are a good choice in particular if you want to avoid forking over a chunk of your earnings to fees. Because they simply seek to track existing indexes (like the S&P 500, for example), they offer built-in diversification without the high fees associated with actively managed funds. Not only that, but they tend to offer more favorable returns to boot. A 2015 Morningstar study found that over the 10-year period from 2004 to 2014, index funds outperformed their actively managed counterparts across almost all asset classes. When you opt for expensive investments, you're not just losing a percentage of whatever amount you contribute to fees; you're also losing a percentage of whatever amount your assets grow into, so be careful about where you put your money.
If you're not already participating in a 401(k) but have the option to do so, now's the time to sign up. Not only will you get an immediate tax break (contributions are made with pre-tax dollars), but you'll get an even greater opportunity to amass a substantial nest egg.
Consider this: If you begin contributing $300 a month to a 401(k) at age 25, you'll have $932,000 by the time you turn 65, assuming your investments generate an average annual 8% return. Wait until you're 45 to start contributing, however, and you'll have just $165,000 when you reach 65. For many retirees, that's the difference between living in comfort and scraping to get by.
Remember: You don't have to max out your 401(k) contributions to make a big impact on your financial future. If you contribute your raise, grab that employer match, and choose the right investments, you'll be well on your way to accumulating enough savings to make for a financially secure retirement.