Even if you're decades away from retirement, you're probably aware that your golden years aren't going to pay for themselves. Rather, you'll need to make an effort to save during your working years if you want to enjoy a retirement devoid of financial struggles. As such, it's crucial that you be aware of the savings options available to you.
Unfortunately, an estimated 30% of working Americans don't know whether their employers offer a 401(k) plan or not, according to a new report by the CFP Board. Of course, getting to the bottom of that question is a simple matter of consulting your workplace benefits manual or speaking to someone in human resources for clarity. But it's an effort worth making, because if your employer does offer a 401(k), and you're not participating, you're missing out on a key opportunity to amass some serious wealth for retirement.
Don't pass up that 401(k)
What's so great about 401(k) plans? For one thing, they come with pretty generous contribution limits that allow you sock away a nice amount of money in a tax-advantaged fashion. But first, know that 401(k)s come in two varieties: traditional and Roth. (Not all plans offer the latter option, but many do.) With a traditional 401(k), the money you contribute goes in tax-free, grows on a tax-deferred basis, and is only taxed when you take withdrawals in retirement. As such, funding a traditional 401(k) means lowering your tax burden for every year you make contributions.
Roth 401(k)s work the opposite way. The money you contribute goes in post-tax, so there's no immediate savings to be reaped. That said, once you fund your account, your money gets to grow tax-free, and withdrawals don't get taxed in retirement.
The contribution limits for both traditional and Roth 401(k)s are the same: In 2019, you can sock away up to $19,000 if you're under 50, or up to $25,000 if you're 50 or older. These limits also tend to rise over time.
IRAs, by contrast, only allow you to save up to $6,000 a year if you're under 50, or $7,000 a year if you're 50 or older. And that's a huge gap that could make a world of a difference.
Case in point: Maxing out a 401(k) from age 35 through 65 at today's limits will leave you with a total of roughly $1.95 million for retirement, assuming your investments generate an average yearly 7% return during that time. Maxing out an IRA, on the other hand, will leave you with just $592,000, all other things being equal. Of course, $592,000 is a lot of money -- just nowhere close to $1.95 million.
But higher contribution limits aren't the only thing 401(k)s have going for them. When you save in a 401(k), you get the opportunity to snag an employer match. Though not every company with a 401(k) offers one, most do. And if you contribute enough money to claim your full match, you effectively collect free cash for retirement.
Imagine that by contributing just $1,000 a year to your 401(k), you get another $1,000 annually in employer matching dollars. If you were to get a free $1,000 for 30 years, and your 401(k) generates the same average annual 7% return used earlier, you'd wind up with almost $95,000 in funds that didn't cost you a dime.
Clearly, there are plenty of good reasons to save for retirement in a 401(k), so if you don't know whether your company offers one, do yourself a favor and find out. And if you do have access to such a plan, aim to start funding it right away, even if you start small and work your way up to higher contributions over time.