Though 401(k)s aren't the only means of saving for retirement, and not all workers have access to one, if you're fortunate enough to have an employer who sponsors a 401(k), it pays to take advantage by signing up for an account. Unlike IRAs, which come with considerably lower annual contribution limits, 401(k)s allow current workers under 50 to put away up to $18,000 a year. Those 50 and older, meanwhile, get a $6,000 catch-up allowance that raises this threshold to $24,000. It's these generous contribution limits that enable so many savers to amass considerable nest eggs in time for retirement.
That said, most workers can't afford to part with that much money each year on a long-term basis, and many of us don't even come close to maxing out our 401(k)s. But what if you could somehow max out your plan contribution for just a single year during your career? It may seem like a far-off goal, but here are a few reasons to go for it.
1. You'll build a larger nest egg
First, the obvious. The more money you put into your 401(k) at any given point in time, the more you'll have by the time you're ready to retire. But what you may not realize is just how much that money might grow to over time if you max out for even a year.
The following table shows how much you stand to gain by contributing $18,000 to a 401(k) in a single year, based on the age at which you do so:
If You Contribute $18,000 to Your 401(k) at Age... |
Here's What You'll Have by Age 65 (Assumes a 7% Average Annual Return) |
---|---|
25 |
$269,000 |
30 |
$192,000 |
35 |
$137,000 |
40 |
$97,000 |
45 |
$69,000 |
If you're wondering how on earth an $18,000 contribution can grow into $269,000 without factoring additional funds into the equation, it's called compounding. The longer you let that money sit and earn a return -- in our example, 7%, which is a bit below the stock market's average -- the more you stand to gain. Case in point: You'll come away with 15 times your contribution if you max out your 401(k) at age 25 and let that money grow for 40 years.
Also, don't forget that these figures account for only that one year of contributions. In other words, if you max out your 401(k) for a year when you're 25 but then contribute just $6,000 annually thereafter, by age 65, you'll have an impressive $1.38 million to your name.
2. You might snag some extra (free) money
Of the many companies out there that sponsor 401(k)s, an estimated 92% are willing to match employee contributions to a certain degree. Yet a good 25% of workers pass up free money each year by not contributing enough from their own paychecks to snag those matching dollars.
If your company's 401(k) includes a matching incentive, you're pretty much guaranteed to get that full match by maxing out your own contributions. And once you do, you'll get to not only add that money to your account balance but also invest it and turn it into something more.
3. You never know when your income might drop
You never know when you might lose your job, fall ill, or encounter an unavoidable change in living expenses that renders you unable to contribute much (or at all) to your retirement plan. Therefore, if you have the ability to max out your 401(k) at any point, it pays to do so while you can. That especially holds true if you max out your yearly contribution when you're younger.
Here's another way to think about it: Say you typically put $6,000 a year into your account, but you have a year where you get an unexpected bonus and use it to max out your annual contribution. If you encounter some financial upheaval the following year, and it takes a good two years to get back on your feet, your savings will essentially remain on track because you'll have "pre-paid" your contributions, so to speak. And not only will that prevent your savings from taking a hit, but it'll also give you some peace of mind if you can't contribute at another point.
Though maxing out your 401(k) for even a single year might require some serious discipline and sacrifice, it'll be well worth it in the end. And just think -- if you're able to pull off that feat one year, you might manage to do so a second year, and another one after that. And that'll really put your nest egg in great shape.