Why a 401K is Important
“Dan, what on earth is a 401k and why is everyone telling me to take advantage of it?”
Many of you have probably heard from your employer(s), “We offer a 401k plan as part of our employee benefits package”. We get excited and ask for more information, only to find out that we must deposit our own money into it and wait decades from now to tap into the funds to use during our retirement years (Starting at age 59 ½, but for some, age 55). This automatically discourages young adults and their older counterparts from taking full advantage of the 401k plan. To be honest, I don’t blame you. When a 401k is explained in that sense, it makes it sound boring and unattractive.
Today, I want to discuss the importance of taking full advantage of your employers 401k plan, and why it should be exciting. I don’t know about you, but more money without working more hours is pretty exciting to me.
- Employer Match- One of the most exciting reasons to start contributing to your employers 401k plan is the annual “Matching Contributions”. An employer match is simply FREE MONEY. To help you better understand this benefit, let’s say you contribute $1000 to your 401k plan this year. Your employer outlines in their Benefits package that they match “dollar for dollar, up to $2000 a year”. This means at the end of the year, your employer will contribute $1000 to “match” your $1000, which will bring you to a total balance of $2000. Essentially, you just earned an extra $1000 by doing nothing extra that year.
- Compound Interest- Albert Einstein once said that, “Compound Interest is the eighth wonder of the world”. The fact that one of greatest scientist in history cited this concept should spark interest into finding out what it is, and how to benefit from it. Compound interest can be understood as putting your savings account on 100 energy drinks. For example, if you deposit $1000 into your 401k and let it “compound” an average 8% interest for the next 40 years, you will have approximately $24,273. This amount is created without contributing an extra penny to the account.
- Tax Benefits- There are two types of 401k options your employer may offer, and both can be utilized in combination of each other depending on your preference. There is a Pre-Tax and ROTH 401k. The Pre-tax 401k does two things, it defers the amount of taxes you owe for that year until you withdraw the funds in retirement and it could very well lower your tax bracket. The ROTH option allows you to pay the taxes you owe now, and when you retire, you can withdraw the funds TAX FREE, including the gains you have made over the years. Both are very valuable and determining which one to use or to utilize both simultaneously is completely up to you.
“Compound interest can be understood as putting your savings account on 100 energy drinks.”
These are only a few of the numerous benefits for taking advantage of your employers 401k plan. I hope that I was able to provide you with additional knowledge and value after reading this article. Most importantly, I hope that you start contributing to your 401k plan today! As always, if you have any questions in regard to financial coaching or mentoring, feel free to use the “Ask Dan” tab so that I can answer all of your questions you may have!
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