The Benefits of a 401k

It's been a while since I've detailed the (great) benefits associated with having a 401k, so when I ran into this piece on Yahoo I knew I wanted to share it. It tells new graduates why a 401k is something they'll want to take advantage of starting with their first job (highlighting three of the best advantages of 401ks.) Now while the article is written for new grads, the facts hold true for all of us. Their thoughts on why 401ks are so wonderful:

• The tax benefits are great. Most grads will fall into the 25% tax bracket (roughly $30,000 to $60,000 in annual taxable income). If that's you and you make a $1,000 contribution to 401(k) account, you're only sacrificing $750 of take-home pay. And you won't pay taxes on the money you invest until you withdraw it 30 to 40 years from now.

• Many employers offer "free money." They'll match anywhere from 25% to 100% of your investment into a 401(k) account. That means you can turn each dollar you invest into up to $2. Never turn down the opportunity for free cash.

• Time is on your side. Even if you invest a small amount now, it can become a substantial asset with the passage of 30 or 40 years. As Schwab puts it, "The power of compounding puts a premium on starting young."

Three great reasons for sure!

If you start soon enough, put in enough, and make sure you're getting decent returns on your investments, 401ks alone can make you a wealthy person by the time you retire. I've taken full advantage of the 401k at my place of employment for years (most of which I've maxed out on each year) and the savings and earnings from them now make up a substantial part of my net worth.

For some more thoughts on this issue, see these links:

• 10 Rules for Building Wealth, Part 2: Use Your 401k

• The Richest Man in Babylon, The Power of Compounding

• Five 401k Mistakes to Avoid

• Some People Think a 100% Return on Your Investment Isn't Enough

Comments

[Greg]

Best of all, you take it with you when you leave the company! Unlike most tradional pensions.

[Dwight K. Schrute]

Question: If your employer matches your contribution to your 401k, does their contribution also count towards your $15,500 limit or is it independent of that? For example, if you personally contribute $15,500 to your 401k, and your company makes a 50% contribution, do you get $23,250 (15,500 + 7750) put in your 401k that year or does it max out at $15,500? Thanks.

[Tim]

Hi Greg,

Your employer match does not count towards the maximum limit.

[Aaron]

I agree that it is a great idea to invest up to your employer match in a 401K. I would caution people that max out their 401K and put all of their eggs in one basket before looking at funding emergency funds and after tax investments like a rothIRA. Although it may seem like the tax savings today are great, remember that you will be fully taxed on that money and all the gains when taken out at distribution - so are you really saving taxes when you will be taxed on it and more when you take it out? Tax rates could go up and your big fat 401K at retirement will be Uncle Sam's best friend. I would prefer to have a balanced plan that gives me access to the money when I need it without a penality.