- 401k is a great tool to build wealth for the future
- Savings for ten years could get to $1,000,000 assuming certain return rates
- Some limitations as to what you can invest in depending on the employer
401k is a retirement program sponsored by your employer that allows you to save your money before taxes are taken out. This allows you to keep more of your money to invest and grow it immediately. You can worry about taxation when you're required to take it out at age 70 or sooner if you the money at age 59. No worries, because by then, your nest egg could be big!
Great, pretax savings is beneficial and compounds beautifully. In 2018 you're allowed to contribute $18,500 into 401k and in 2019 that limit goes up to $19,000. This money is not taxed and goes straight into your 401k account.
In addition, many employers offer something called a "match". If you save above a certain amount, they will match for example 3% of your yearly salary. That means if your annual salary is $75,000, you will receive $2,250 in your 401k account from your company. This is just one example, but matching versus your salary grows, allows the overall contribution to keep on rising!
Don't even think about withdrawals before age 59.5. If you do so, you must pay a 10% penalty and your ordinary/required tax rate.
Investment choices are typically pre-selected by your employer. This could be limiting, depending on the scope of what they offer, so take a close look at your options. Hopefully you'll be able to find the variety you need plus some fairly reasonably priced mutual funds and ETFs in there. Plans typically offer flexibility to keep the 401K with your current employers or roll it over to your new employer when you change jobs.
Let's use a simple example. Say for 10 years you make $75,000, you max out your 401k at the current $18,500 limit and receive 3% match on your salary ($2,250). Using a moderate growth rate of 7% for 10 years you would have almost $300,000! If you didn't use 401k, your investment without the tax benefit would only be worth roughly $140,000 (pre-tax $185,000, less anticipated taxes of $45,000).
Now let's say you decide to stop using 401K and just leave the money you saved for those ten years. You just let it sit there until you retire 20 years from that date. You would have $1.1 million dollars!
That's compounding folks! We are not fans of doing these long term, 40, 50 years projections. In this example, just saving for 10 years, then let it sit. In year 30 you join the ranks of millionaires. Start today!
- Pretax saving: Delay paying taxes to a later date. Usually in retirement you will be in a lower tax bracket.
- Compounding: More of your money is in investments allowing you to grow faster.
- Match: Employers usually match up to certain percentage of your salary. Free money!
- Flexibility: Even if you change employers, you may leave it in your current plan, or roll it over with no costs.
- Meaningful nest egg: 401k is a great tool to build a meaningful nest egg for the future.