Why you need to contribute to your 401k
The first account I ever used to begin investing was through my employer-sponsored savings plan — a 401k retirement account. I realize there are investing wizards out there who bought stock in Apple and Microsoft in 2005. Not me. Not because I do not think investing in blue chip companies is a great way to grow your investments, but because I did not know about the world of *investing.*
If you are a young person or anyone trying to maximize your tax benefit while also planning for retirement, but have no idea where to begin -- I got you.
It is a 401k.
In 2017 I began contributing to my 401k. My employer at the time matched up to 3% of my contribution. I was making $15 an hour and I was not really sure if I could afford to invest anything into my 401k account, but alas, I began contributing $50 per pay period.
In hindsight I would tell myself to not be so hesitant to contribute to retirement for two reasons:
Contributions to your 401k are pre tax - this means that you are not paying taxes into the money you contribute.
Let’s say in 2024 you make 50k per year and contribute 10k, without taking into consideration your tax filing status or standard deduction or anything else, you are looking at a taxable income / adjusted gross income (AGI) of 40k for that year.
Note: some employers will offer a pre-tax and Roth 401(k) contribution. A pre-tax contribution reduces taxable income but taxes are paid once the money is withdrawn, whereas contributions to a Roth 401(k) are done with post tax income. This does not reduce taxable income, but withdrawals are tax-free since you already paid taxes on that income.
2. Retirement plans held by your employer are invested based on your retirement age (Target-date fund). This means if you are someone in their 20s, your retirement fund will not look the same as someone who is in their 50s and is closer to retirement as in different target date funds. The goal of a target date fund is to maximize the investor's returns by a specific date -- the closer you are to retirement, the less risky the investments in the fund will be.
Personally, I think dipping your feet into the world of investing and saving for retirement through an employee sponsored plan is great because aside from deciding how much to contribute each year and rolling over your 401k account once you leave* -- it's the perfect out of sight and mostly out of mind investment for your future.
What if I don’t make enough to maximize the maximum contribution?
Pay yourself first!
Increasing my 401(k) contribution each time I got a raise allowed me to reach the maximum contribution limit, without feeling deprived as I never really increased my lifestyle to match the raises.
For example, let’s say I got an 8% raise, I would increase my 401(k) contributions by 4% and spend the remaining 4% on me.
By slowly increasing the amount I contributed, saving for retirement became sustainable because:
I was able to plan and fund my lifestyle with the money I was currently making, and I did not “pay myself” much more each time I got a raise. In case you were wondering, it took me about three years of working full-time for me to be able to make that happen.
Lastly, in case you were curious about the 401(k) contribution limits, the IRS has released new retirement contribution limits for 2024.
401k contribution limit in 2024:
*rolling over or taking a look at the 401k account after parting with an employer can possibly save you from hidden fees since you are no longer with the former company.
Something to note:
A 401(k) plan is designed to provide income once you retire. Withdrawing from that account prior to age 59 ½ will be subject to a 10% penalty in addition to any taxes owed. Based on that, it would be prudent to not withdraw that money as it can be pricey.
Long Story Short:
I think contributing to an employee sponsored retirement account is a win-win situation, especially if you have an employer who contributes a certain percentage of your contribution. I would begin small and scale up my contributions.
As always, feel free to share your journey or feedback at elizabeth@firstgenrich.com
Until next time.
ED
