What exactly is a 401k?
A 401(k) is a retirement contribution savings account removed from an employees paycheck before tax and can only be withdrawn from after retirement. While the 401(k) is mostly popular, there are other iterations of this kind of retirement account. There is the 403(b) for non-profit employees, and the 457(b) for government employees. The current maximum contribution for this account is $18500, but if you can’t afford it, start with something.
If you are currently not contributing to one of this, allow me to tell you why you should.
Free money: A lot of employers have matching for a 401(k). This means that when you contribute a certain percentage of your income, the employer will contribute that percentage or a percentage. For example, my employer will contribute 4% if I contribute 5% of my income. This varies by companies, and you have to understand what you employer’s requirement is. In the example, that 5% will yield an automatic 80% return on that contribution.
Compound Interest: Many of us learned compound interest in school. If you didn’t, allow me to tell you the benefit of compound interest.
For example, if you put $5000 into a savings account, with 5% interest, after the first year you get $250 interest. That interest will also earn interest with the principal, and after 10 years, the money would grow to over $8000. This is without doing anything extraordinary. Imagine the returns if you make monthly contributions over a long period of time with employee contributions. Time is of the essence in compound interest, so use the time you have now.
Lower taxes: Since a 401(k)/403(b)/457(b) is a contribution made before tax. It reduces your tax burden per year. I don’t know about you,but I don’t know anyone who likes seeing a large sum of their income go to the income. Contributing to this account could take you from a higher tax bracket to a lower tax bracket per year.
Forced savings: Making this contribution forces you to save. The percentage is taken directly from your paycheck before you see it. Since you don’t have access to it, you can’t make plans on money you don’t see. It is easier to save when it is automated than when you have access to the money first, even for a financially scrupulous person.
If you think you don’t make enough money to contribute to one of these account, start with as little as 1%, and you can adjust your contribution every quarter or however you feel comfortable.