There's going to come a time in all our lives when we can no longer work, whether that be physically or mentally, or both. That's the time when our investments should be generating enough income to live on. That's why we need to get out of debt so we can start saving for retirement.
Deferred Income and Taxes
By deferring your income, you won't pay taxes on it TODAY. Contributions to a 401(k) allow you to do just that. If your salary is $40,000 a year and you contribute $5,000 to your 401(k), your W-2 will show $35,000, and that's the starting amount you'll use to calculate your taxes. Keep in mind you will however, owe taxes on the amount when you take it out. Take it out prior to age 59 1/2, other than for a few exceptions, you'll owe an additional 10% penalty to Uncle Sam. Thought: taxes will probably increase, so you may want to contribute the money AFTER tax, which means you'll pay taxes on it now, and it will be tax-free upon withdrawal.
Many Companies Are Helping 401 (k) Match
Companies can help their employees in two ways:
- 60% of companies with 401(k)'s are automatically enrolling their employees in the company 401(k). While this is rather paternalistic on the part of the employer, participation rates are 18% higher for those subject to automatic enrollment. Why are the participation rates not 100%? The employee can opt-out. However, in 85% of those companies automatically enrolling their employees, only new employees are affected. The participation rate of eligible employees is at an all-time high of 75.8%, up from 67.2 in 2005.
- Many companies offer a match to the employee; if they contribute, say, 6% of their salary, the company will match it, perhaps not dollar-for-dollar, but there could be a match. This is free money. If you have a 401(k) with a match and you don't contribute to receive the full match, you're leaving money on the table. 30% of eligible employees contribute below the company match.
Because of the default rate of the automatic contribution being below 4%, those that are automatically contributing are contributing 1% lower than those without automatic enrollment. Average contribution rates for 2011 are 7.3%, down from 7.7% in 2007. Saving 1% less over a career can translate into 15% less income in retirement.
The 1% Plan
Let's say you're making $40,000 a year. What's 1% of that? $400. Take the $400 and divide it by 52 weeks; that's less than $8 a week; less than a lunch. You start doing this each year, and you'll find your contribution rate soaring to 15% before you realize it.
Do you contribute enough to your company 401(k) to receive the full match?