Last year, my nephew graduated from college and was getting ready to begin his first job out of school. It was an exciting time and I was very proud of everything he had accomplished in his young life. I told him that I was only going to give him one piece of advice: if your company has a 401(k) plan, contribute as much to it as you can afford from the very start. You will get used to not having that money in your paycheck, and utilizing the concept of the time value of money, you will be amazed at how much you will save in 30 years.
So, what is a 401(k) plan and how can it serve as an effective vehicle for accumulating retirement income? A 401(K) is an employer-based retirement savings plan that allows you to save money toward your retirement on a tax-deferred basis. In other words, you don’t pay federal or state taxes on your savings or their investment earnings until you withdraw the money at retirement. With most 401(k) plans, money is deducted from your paycheck before taxes are withdrawn which lowers your current taxable income. Some plans also offer a Roth Option where you pay the taxes upfront and contribute after-tax dollars. Accordingly, there is no tax liability when you withdraw the money when using the Roth. With the uncertainty about future tax rates, it is worth considering using both options if available.
Many employers match a portion of the contributions employees make to their 401(k) account. The matching amount varies but it’s usually 25 to 100 percent of your contributions, up to a set percentage of your pay. You may have to work for the company for a minimum period of time before you become 100 percent vested in the company’s matching amount. You are always 100 percent vested in your own contributions.
There are no guarantees in life, but if you start investing early with a smart allocation strategy, chances are very good that you could retire with a sizeable nest egg. Start early and stay the course.