Though not everyone has access to an employer-sponsored retirement plan, if you happen to have a 401(k) at work, consider yourself lucky. These plans offer a great opportunity to bank some serious bucks for the future, and the sooner you take advantage of one, the more wealth you stand to accumulate. Here are just some of the terrific features 401(k) plans offer today.
1. Generous annual contribution limits
Though you don't need to limit your long-term savings to a specific retirement plan like an IRA or 401(k), keeping your money in such accounts has its advantages. But whereas IRAs max out at $5,500 a year for workers under 50 and $6,500 a year for those 50 and older, 401(k)s allow you to contribute much more. Currently, the annual limits are $18,500 for workers under 50, and $24,500 for the 50-and-over set. Keep in mind that these numbers represent a $500 increase from the previous year, and may very well go up again in the future.
2. Employer matching dollars
When you save for retirement in an IRA, the money that goes in all has to come from you. Not so with a 401(k). It's estimated that 92% of companies that sponsor 401(k)s also match employee contributions to some degree. The result? The potential for free money just by participating.
3. Tax-free contributions
We all want to lower our taxes, and 401(k)s let us do just that. When you fund a traditional 401(k), the money you contribute goes in on a pre-tax basis, and your savings become a function of your effective tax rate. This means that if you typically lose 25% of your income to taxes and contribute $10,000 in a given year, you'll save a cool $2,500 right off the bat.
4. Tax-deferred investment growth
When you invest in a traditional brokerage account, you're required to pay taxes on gains each year you take in those profits. The beauty of traditional 401(k) plans is that they offer tax-deferred growth on your investments. This means that you don't pay taxes on your gains year after year, thus enabling you to reinvest your earnings and grow your nest egg even more. It's only once you reach retirement that you pay taxes on the money you withdraw, gains and all.
5. Early access to your money
Because traditional IRAs and 401(k)s offer tax benefits for contributing, you're required to leave your money untouched until you turn 59-1/2. But under limited circumstances, you can actually access your 401(k) dollars a bit sooner. In fact, you can take penalty-free withdrawals from your 401(k) at age 55 if you leave the company sponsoring that plan once you reach that age. IRAs don't offer this same flexibility (though there are circumstances under which you can access your IRA funds ahead of schedule without penalty as well).
6. Delayed required minimum distributions
The money you have in a traditional IRA or 401(k) can't just sit there forever. Once you turn 70-1/2, you're actually required to start removing a portion of your account balance each year. These withdrawals are known as required minimum distributions, or RMDs, and if you don't take them on schedule, you risk a 50% penalty on whatever amount you fail to withdraw. This means that if your RMD for a given year is $4,000 and you don't remove that amount, you lose $2,000.
Now the problem with RMDs is that they automatically trigger taxes on your actual withdrawals, so that if you don't need the money, you wind up paying the IRS needlessly. The good thing about 401(k)s is that in some cases, you can delay your first RMD past 70-1/2. Specifically, if you're still working at that time and don't own 5% or more of the company employing you, you can hold off on RMDs until you leave that job. This will help you avoid taxes while giving your money extra time to grow.
If you're still not convinced that it's wise to sign up for your company's 401(k), here's one more thing that might have an impact: If you don't save independently for retirement, you're likely to struggle financially as a senior so that while all of your friends are busy traveling and hitting the golf course, you'll be barely scraping by. On the other hand, if you contribute a mere $300 a month to your 401(k) over a 40-year period and invest that money at an average annual 7% return, you'll come away with well over $700,000. And that's reason enough to participate in a 401(k) if you have the option to do so.
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