It's unfortunate that only about 60% of the current workforce has access to a 401(k) plan. Because of their generous annual contribution limits, 401(k)s offer workers ample opportunity to grow their nest eggs for retirement.
If you're already contributing to a 401(k), you're off to a good start. That said, if you're not maxing out your annual contribution limit, which is currently $18,000 for workers under 50, then you may want to think about increasing those contributions. The more money you put into a 401(k), the more you'll lower your tax liability, and the more you stand to accumulate over time. Furthermore, you should especially make sure to contribute enough to take full advantage of whatever matching dollars your employer offers.
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The benefits of 401(k)s
The beauty of 401(k) plans is that they allow your money to grow on a tax-deferred basis. This means that if your investments make money, which they hopefully will, you won't pay taxes on your gains until the time comes to take withdrawals in retirement. Funding a 401(k) at a relatively young age will also allow you to take advantage of compounding and turn a series of smaller contributions into a sizable sum down the line.
Another great thing about 401(k)s is that contributions are deducted from your paychecks before taxes. This means you'll save money in the near term just by funding your account.
While other savings options, like IRAs, offer similar benefits, 401(k)s have generous annual contribution limits that allow for even more growth. Currently, workers under 50 can put up to $18,000 in tax-free earnings into a 401(k) each year, while those 50 and older get a catch-up provision that raises this limit to $24,000. Now most people can't max out their 401(k)s, or even get close. But the more you are able to contribute, the better.
Are you getting your full employer match?
Another feature of 401(k)s that makes them so valuable is the employer match. It's estimated that more than 90% of companies offering 401(k)s also offer some type of matching incentive. Unfortunately, a good 25% of workers don't contribute enough of their own money to take full advantage of it.
And we're not talking small amounts, either. Those who don't snag that match are leaving a whopping $24 billion on the table each year. Ouch. This means that countless workers are not only passing up free money, but whatever growth that free money could've achieved.
Every dollar counts
Now you may be thinking: How much do I really stand to gain by increasing my 401(k) contributions? And the answer is: a lot.
But don't just take my word for it. Rather, plug in some numbers and see for yourself using the following handy calculator:
* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
Imagine you earn $50,000 a year and your salary goes up 3% annually. Let's also say that you're currently putting 5% of your salary into your 401(k), and that your employer is among the few that doesn't offer a match. Assuming you're 30 years away from retirement, and that your investments generate an average annual 8% return (which is just below the stock market's average), by sticking to that 5% savings rate, you'll have an ending balance of $419,537.
Obviously, that's a pretty impressive number, but watch what happens when you increase your savings rate by just 2%. If you contribute 7% a year rather than 5%, you'll wind up with $587,352 -- a $167,815 difference. Better yet, that extra $167,815 will only cost you an additional $47,575 in contributions, which means you'll be looking at a pretty sizable gain. It clearly pays to contribute as much as you can to your 401(k), even if that means making sacrifices along the way.
Increasing your contributions
Of course, ramping up your 401(k) contributions is easier said than done, especially if the rest of your income is already accounted for. But here are a few things you can try:
- Any time you get extra money, put it in your 401(k). Your 401(k) contributions don't have to be steady. You can stick your performance bonus, tax refund, or birthday gifts directly into your account as you collect them.
- Cut back on a few small luxuries. Choosing a lower-end cable package, eliminating one restaurant meal per week, and walking to work a few times a month in lieu of taking a cab can all free up cash that can be used to fund your 401(k).
- Consider a side gig. If there's really no wiggle room in your budget, working a few nights a week or a couple of weekends a month is a guaranteed way to get your hands on extra money.
The more you put into your 401(k), the larger a nest egg you stand to accrue over time. And while increasing your 401(k) contributions might take some effort today, you'll be thankful for the extra money when you have it in retirement.
