Contributing to your 401(k) is the easiest way to put yourself in a better financial position in the future. If you only have time to do one thing, this is where to start. Here are three reasons why.
- It's simple
It's a very simple to take action. Just contact your HR department or go online to your 401(k) plan administrator’s website.
By enrolling in your 401(k) plan you're automatically saving and investing for retirement without having to pull the money from your paycheck yourself and then move it into an investment account. You can work towards your long-term financial goals without being distracted by your short-term goals.
Let's look at it this way, you have a goal to start eating healthier. You know that this takes discipline, and is typically very difficult to get started. If you were to subscribe to a program like Blue Apron, though, that sent you regular meals with fresh ingredients that you'd then put together yourself, it probably wouldn't be as difficult to get started or to stick to it. You'd be removing several difficult steps like finding a recipe and then going to the grocery store to pick up the ingredients. The process and discipline has been removed and all it takes for you to reach your goal is to prepare and consume the food.
Once you've set up your 401(k) contributions it's a little like this. You'll eliminate the difficult steps of saving, and immediately accomplish your goal of putting money away for your future retirement.
2. You get tax benefits today
Another reason to embrace your 401(k) is because of the tax benefits you'll receive today. The money that you contribute to your 401(k) is generally tax-deferred, meaning that you will pay taxes on it once you pull the money out of the account in retirement. Because of this, the amount of money you contribute to your 401(k) lowers your taxable income today.
For example, let's say that you have a household income of $90,000 a year, and you and your spouse each contribute $5,000 into individual 401(k) accounts. The U.S. government then will tax you based on a household income of $80,000. If you are married filing jointly, for 2015's taxes you might drop you from owing roughly $9,488 to $7,988. That's some significant tax savings!
An additional bonus to pre-tax savings is that you have a larger amount of money invested. More money = more compounding typically.
3. Free Money!
About 95% of 401(k) plans provide a company match, and the average company match is about 2.5% of an employee’s pay.
Let's use the eating healthy example here again. Imagine that after several months of using Blue Apron, they sent you a gift card to your favorite clothing store so you could buy smaller size clothing.
That’s what an employer match can do for you. It’s an extra benefit for doing something that you should do anyway. Again, it's free money!
The (Perceived) Negatives Of 401(k)s: There are a few things about saving in a 401(k) that some people don't like.
You can’t touch the money until you’re 59.5 without paying a stiff penalty. While this might technically be a negative, this policy is in place to help you reach your long-term goal of retirement. (We count it as a positive.)
Another drawback to 401(k)s is that they typically have a limited number of investment options, and the options are often expensive mutual funds. The good news on this point, though, is that today ETFs are being introduced in many 401(k) plans. These are less expensive investment vehicles.
When it feels like there are a million suggestions and “to-do’s” you sometimes need an easy win. Something that has a big impact, but that's an easy adjustment to make or to get started. Contributing to your 401(k) could be your easy win. Any financial matter like this is dependent on your own specific situation; however, generally speaking contributing to a 401(k) or another retirement plan has far reaching benefits for most investors.