Participating in your company 401(k) plan lowers your tax bill and makes monthly saving automatic. Meanwhile, your money grows tax-free. That’s a good thing.
One of the most powerful advantages of participating in a 401(k) is the money you save in taxes. Your 401(k) contributions are taken out of your paycheck before taxes are deducted from your paycheck. That means your gross income is reduced, so you pay less in income taxes.
There’s more. As your 401(k) grows in value over time, you don’t pay taxes on those gains like you do with a bank account or individually owned stocks or mutual funds. You only pay taxes on your 401(k) when you begin to withdraw the money at age 59 1/2, when you may be in a lower tax bracket.
Because you’re not paying taxes on any gains from the account, your 401(k) money can grow more quickly, year after year, than many other types of savings.
Let’s face it, most people have a hard time setting aside money for savings each month. 401(k)'s take care of that with “forced” savings. The money is automatically moved from your paycheck to your 401(k) account before you can get your hands on it. With a 401(k), you are in effect paying yourself first – with money that otherwise would have been spent. Year over year and that can add up to big savings. Of course, the earlier you start, the bigger your 401(k) can grow. If you receive a pay raise at work, it’s a good idea to increase your 401(k) contribution so you continue to save at the same rate.
Employer matching contributions
If your employer offers a matching contribution, that’s free money to you. The more your employer matches, the less you have to save on your own. Always take advantage of an employer match and contribute at least the amount they will match.
* This illustration is a hypothetical compounding example that assumes biweekly deferrals (for 30 years) at a 7% annual effective rate of return. It illustrates the principle of time and compounding. It is not intended to predict or project the investment results of any specific investment. Investment return are not guaranteed and will vary depending on investments and market experience. If fees, taxes, and expenses were reflected, the hypothetical returns would be less.