Does the title of this post sound a tad dramatic? So be it. Retirement savings is serious business, and the 401K is a hardy soldier in the fight against the proverbial cat food in retirement. I started my new full-time position a few weeks ago. With every new job comes new people, new responsibilities, new procedures, and of course, new retirement plans. One of the most important decisions you will make at a full-time job, financially-speaking, is whether to contribute to your employer-sponsored retirement plan, the 401K (or 403B for non-profit organizations). I've waxed poetic about the virtues of the Roth IRA. But if you truly want to kick your retirement into high gear, you also need the 401K.
The name "401K" stands for a section of the tax code that allows employees to contribute part of their salary, pre-tax to a 401K, where it can grow and compound, tax-free, until the employee decides to withdraw. The withdrawals will be taxed at the employee's tax rate at the time of the withdrawal. In a Roth 401K, the employee will contribute after-tax amounts, the money will still grow tax-free, and when the employee withdraws the money the withdrawal will be tax-free.
Most medium-to-large companies offer 401K plans, and many smaller companies do so as well. In the past several years, companies have increasingly offered employees a choice of traditional 401Ks or Roth 401Ks, although the traditional 401K are still by far the more common offering. In 2010, the contribution limit to the 401K is $16,500 for most employees, and workers older than 50 have a $5,000 catch-up provision that allows them to make $21,500 in 401K contributions total.
Why is contributing to the 401K one of the most important decisions at a new job? For me, there are four reasons:
(1) The 401K is one of the easiest ways to save. Just tell your employer how much of your salary you'd like to put away, and the amount will be deducted from your paycheck. Some employers will even automatically enroll you in a 401K program unless you tell them "no". But for most employees, they just have to make the choice to be disciplined once.
(2) Many companies also include a 401K match - often 50 cents on the dollar for a maximum of 6% contributed - which means that if you have such a match and you don't contribute to your 401K, you have effectively passed up on an additional 3% of your salary.
(3) 401K contributions lower your taxable income. If you make $60,000 a year, but you have managed to save 10% of your income in a 401K, your federal taxable income will be lowered by $6,000 a year.
(4) When you leave your job, the 401K is also easy to take with you. Just roll the money into a Rollover IRA. Make sure to do a "trustee-to-trustee" transfer, and you won't be taxed on the procedure. Whatever you do, don't take money out of your 401K. Your 70-year-old self will thank you.
When I contribute to a 401K, I first err on the side of over-aggressiveness. If I really can't make the ends meet, well, it's easy enough to lower my contribution levels (often by the click of a mouse). But many times I've found that I can be thriftier than I think - I can make do with less, and watching my retirement savings grow at a steady clip has made me feel almost as good as a new jacket or a dinner at a swanky bistro. I'm standing up for retirement, one percentage of contribution at a time.
The 5 Minute Guide to 401Ks [Squawk Fox]
401K contribution maximum [My Open Wallet]
Choosing between multiple investment options [My Money Blog]
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