Savings Options - 401(k)

401(k)
Last week I talked about the savings rate hitting a 15 year high and showed how you could calculate your disposable income. Over the next series of posts I will describe some of the savings vehicles you should consider for some of this disposable income.

The first and probably most important savings vehicle is the 401(k). For those of you who work for a school district or non-profit, you might have an option called a 403(b). If you are able to invest in a 403(b) you should do so. While not exactly the same as a 401(k) it offers many of the same benefits and should be one of the first places you set aside some of your disposable income.

If your employer offers a 401(k) you need to get into this program, if you are not already enrolled. If you are enrolled, you need to examine your level of contribution.

A 401(k) is a tax deferred retirement plan that is established by employers to which eligible employees may make salary deferral contributions on a pre-tax basis. Employers offering a 401(k) plan may make matching contributions on behalf of eligible employees and may also add a profit sharing feature to the plan. Earnings in the account grow on a tax deferred basis which means you only pay tax when you withdraw the funds. This is typically after retirement when you are probably in a much lower tax bracket.

Many employers match any contributions you make up to a certain maximum. If you can, you should contribute at least as much as the company match, and more if you can afford it. For example, if the company will match 50% of all contributions up to 5% of your annual salary, you should make sure you are contributing at least 5%. The company match is essentially free money and will help you to grow your retirement balances even faster.

Learn a lesson from me on this one, put away as high a percentage as you can right away. When I started I put 1% of my income into this plan and thought I couldn’t afford to do any more. I then increased it to 2% and was amazed at what a difference it made. Now, I max. out my contribution. I just continue to wonder what my 401(k) balance could have been had I maxed out as soon as I was eligible. While I don’t know what the actual number would be, I do know it would be significantly more than I have now.

To illustrate the power of this, check out the numbers. For illustration purposes lets assume an annual salary of $40,000, a 5% rate of return on the 401(k) and the company match noted above. Contributing 1% of your salary would result in a balance at the end of 25 years of $29,406, increasing that contribution to 5% would result in a balance at the end of 5 years of $147,030, a huge difference.

If you are not currently enrolled in a 401(k) plan at work, enroll today!

If you are not maxing out your contribution, find a way to max. out your contribution. A little more saved today in a 401(k) will turn into a big nest egg in the future.