The Importance of 401Ks
Pension plans are disappearing, and very few employees who have just entered the workforce will ever see one (consider yourself lucky if you have one). I have my doubts about the ‘danger’ that Social Security is in, but I would not put it past Congress to make significant cuts.
Assuming that it is all propaganda and Social Security will mean the same to you later in life as it does to today’s retirees, you still cannot count on it as your only source of income in your later years (at most it probably will only cover about 25% of the income that you will need). That means that the lion’s share of your retirement funds are going to come from your 401K (Roth 401K or pre-tax) and personal IRAs. We’ll stick to 401Ks for this post.
Hopefully you have all enrolled in your employer sponsored 401K plan. If you haven’t, jump on it. Below, you will find a top 5 list of why you should be plugging away into your 401K.
The Benefits of Saving in a 401K
1. Free Money:
How can you turn down free money? Most employers will sponsor 50% or even 100% of your contributions on up to a certain amount. You might as well forget about any mutual fund or stock getting you an average return of 50 or 100% in the market over the long-term, but your employer is willing to give it to you at no risk as a benefit. If you can afford it, the default should be to at least get the 401K match max that your employer is willing to give you.
As luck would have it, my employer is matching 50% of what I contribute on up to the 2022 maximum 401K contribution of $20,500. That means, they are giving me $10,250 for my retirement. Free. I’d be crazy to turn that down!
2. Assume the Worst
OK, let’s assume that Social Security won’t be there for you when you retire. Experts say that you’ll want to replace at least 80% of your income in retirement. But, who wants a lower standard of living in retirement, right? Live it up, you’ll want at least 100% of your income in retirement.
3. Lower your Taxes
Assuming you are investing in a pre-tax 401K (vs. a Roth 401K), you are lowering the income you will be taxed on at the end of the year by the amount that you are putting in your 401K. There is debate as to whether you are better off investing in a pre-tax or a post-tax Roth (which you don’t pay taxes on in retirement), but I am personally investing in a pre-tax because I figure that my expenses right now in life are higher (think mortgage, education, etc.) than they will be in retirement and I’d rather be taxed at a higher rate in retirement than now.
4. Set it and Forget it
You adjust to what you have. If you never see that money in your bank account, you really don’t miss it. REALLY. It’s taken out every time, it becomes routine, and there’s nothing you can do about it but adjust.
5. Compound Interest
The biggest mistake you can ever make when it comes to finance at a young age is think that you can fore-go saving now because you think you’ll have more money later in life. You won’t. You’ll move into a bigger house, want nicer cars, churn out a few pups, and maybe go through a divorce or five. Save now, while you can and let your money go to work. Compound interest is the most powerful financial weapon in the world. Let your money work for you early and often so that you don’t work yourself into the ground when you should be living it up in retirement.
Are you enrolled in your employer’s 401K? How much are you contributing?