How to Get the Most Out of your 401k

How to Get the Most Out of your 401k

Let’s be honest. There’s nothing less-sexy than taking money out of each paycheck, and stashing it away for retirement. Especially when that shiny new BMW is calling your name. Unfortunately, with taxes steadily climbing, pensions virtually non-existent, and fewer Social Security benefits expected for Millenial’s, it’s important that you start saving now.

During the Baby Boomer generation, employers were expected to care for their employees. Sadly, that’s changing, and now the burden is being pushed onto the individual. Unless you’re expecting a large inheritance from your long-lost Uncle, you’d better get started.

As of this writing, only 60% of employers offer a 401k program. Of that 60% that do, only 51% of them offer matching funds. Even more, most people only save when they’re required to. The average personal savings rate is at a minuscule 5%. The total savings account and investment balance of an average American worker contains less than $25,000.

With these daunting odds placed against you, here’s a few tips on how to get the most out of your 401k.

Maximize Matching

The average employer match comes to a whopping 3%. While not a lot, a 401k match is still your quickest and easiest way of boosting your income. Most employers have fine-print writing that says they will match 50% or 100% of your contribution (up to that 3%). Where else can you find an immediate 50-100% return on your investment? Absolutely make sure that you are doing everything in your power to receive your employer’s full employee match. If you don’t feel you can set aside 3% of each paycheck, think again. You can’t afford NOT to. Anything less than the full match is leaving free money on the table.

Many 30 or 40-somethings look back upon the first 10-20 years of their career, and regret not participating in their company’s 401k plan sooner. They missed out on the thousands of dollars offered to them, as well as the compounding interest that comes with time. If you’re not actively participating in a 401k program, start now.

Contribute more to save on taxes

While 3% is generally the starting point for contributions as well as employer matchings, don’t let that limit you. 401k contributions are tax deductible, so set aside as much as you can. The maximum 401k contribution limit for 2017 is a generous $18,000 per year, per person. Most Americans fall in the 25-28% tax bracket. This can result in a total tax savings of $5,040. That’s nothing to scoff at.

Contribute to your 401k as early as possible

The effects of compound interest are powerful. If you were to place $5,000 into a 401k in your twenties, never touch it, and never contribute any additional funds, (please don’t do this — keep contributing!) when you’re ready to retire, you’d be looking at $120,229. That’s a huge return on your investment, for quite literally doing nothing. Assuming the same situation, and never contributing anything ever, if you start at 30 with that same $5,000, you’d be looking at $61,000 instead.

Again, please please contribute to your 401k regularly. The above numbers are simply to illustrate the effects that time can have on investments.

With compound returns, time becomes your biggest asset. You always have tomorrow, but you’ll never get back yesterday.

Avoid 401k loans

401k loans are a way of borrowing money, and then paying yourself the interest back to yourself, rather than a bank or credit union. While this might sound good in principle, generally speaking, the cons generally outweigh the pros. You’re stealing money from your future self, in order to pay for today. With a 401k loan, let’s say you borrow $10,000 for an auto loan. Your 401k balance now drops from say $100,000 to $90,000. While you may be paying yourself interest, what you’re missing out on is the opportunity cost. You could be earning money via interest on the additional $10,000 in your 401k, but instead, you tried to save yourself the 3% on an auto loan.

401k loans often come with yearly maintenance fees, loan origination fees, and other charges than can easily add to a couple hundred dollars.

Not to mention, if you lose, quit, or change jobs, often times your loans need to be paid in full immediately.

Whatever you do, if you do decide to take a loan against your 401k, absolutely ensure that you pay it back entirely. The penalties on not paying off that loan can be devastating.

NEVER take a 401k Early Withdrawal

As the balance in your 401k slowly begins to climb, it can be tempting to want to tap into it early to pay for a big vacation, a new car, or even that unexpected roof repair. But it is never worth it.

Let’s take Corey, for example. Let’s assume Corey runs into some unexpected medical bills, and wants to pay them off quickly. Corey cashes out $14,000 from his 401k. Because he files his taxes as single, and he earns $50,000 a year, this places him in the 25% tax bracket. Don’t forget that he lives in Illinois, which tacks on another 3.75% for state taxes.

Starting: $14,000
– 25% Federal Income Tax ($3,500)
– 10% Early Withdrawal Fee ($1,400)
– 3.75% State Tax ($525)
————————-
Actual distribution amount: $8,575

$8,575 is only slightly over half of the $14,000 Corey thought he would be receiving. Not only does he love $5,425 right off the bat, this doesn’t take into account what Corey will be missing out on by not keeping his money invested over time, leaving him with substantially more.

Simply put, don’t ever withdraw funds early.

Be smart now, reap rewards later

Your 401k is your most basic tool for reaping humongous rewards in retirement. What may seem like little things here and there over your working life can amount to huge rewards later. Do everything in your power to maximize your contributions, and curb your temptations to tap into your savings early. You’ll be much happier in the long run.

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