Why You Should Start Contributing to Your 401(k) as Early as Possible
Years ago, most companies offered pensions to employees. These employer-maintained retirement accounts ensured the employee would receive income, either monthly or in one lump sum, based on how long they worked and how much they earned. That’s no longer the case.
In fact, a study from Towers Watson found that the number of Fortune 500 companies offering traditional pension plans dropped from 251 to 34 between 1998 and 2013. Most companies have shifted to 401(k) plans, which means employees are responsible for the contributions to and oversight of their retirement plans.
Unfortunately, Americans aren’t very good at saving for retirement. In fact, a GoBankingRates survey found that one-third of Americans have nothing saved for retirement. Another 23 percent have saved less than $10,000. 13 percent have saved more than $300,000, which was the top bracket in the study.
On average, Social Security will replace about 40 percent of your income. If you want to maintain your current lifestyle in retirement and avoid becoming a burden to loved ones, you’ll need to replace about 70-90 percent of your income. If your employer offers a 401(k) plan, contributing as early as possible could be the best way to fill that gap.
A Hypothetical Example of 401(k) Growth
Suppose you’re 25 years old and are just starting your 401(k). If you contribute $5,000 in the first year and continue to contribute each year until you retire at 65, your estimated 401(k) account balance would be $506,777, according to the U.S. Department of Labor’s income calculator. This assumes an annual contribution increase of 3 percent, very modest growth of 7 percent, and an inflation rate of 3 percent.
Tips for Getting Started with Your 401(k)
The current maximum you can contribute to your 401(k) each year is $18,000. Individuals age 50 and older can contribute an additional $6,000. We’re not saying everyone should make the maximum contribution or create a financially stressful situation, but you should contribute something.
Find out what the minimum contribution is. There’s nothing wrong with contributing as little as 1 percent. That money will start to grow, tax-free, until you begin to take funds from the account, and you can increase your contribution as you’re able. Also, find out if your employer matches any or all of your 401(k) contributions. An employee match is essentially free money, so take advantage of this benefit.
If you’re not sure about which investment options to choose, ask for help. Everyone has a unique situation and risk tolerance but, generally speaking, the younger you are, the more aggressive you can be. Because it’s a long-term investment, your 401(k) will be more resilient to market volatility.
If your employer offers automatic enrollment, don’t opt out! Many employers are offering auto enrollment into 401(k) plans for employees, which simplifies the process of getting started.
Employers, Are You Encouraging 401(k) Participation?
Auto enrollment is one way to increase participation. Of course, many younger employees need to be educated about how to contribute to a 401(k) and the value of contributing to a 401(k). Instead of handing them a manual, engage your employees. Encourage questions and address their concerns. Make sure they have access to plan information.
Consider increasing your company’s match if financially feasible. Retirement plans are an important part of your company’s overall benefits package that can help you attract top talent and reduce turnover.
The Bottom Line
When you eventually retire, it’s not about how much you made. It’s how much you saved that will determine whether you outlive your money. If your employer offers a 401(k) plan, contribute as much as you can afford. If you’re not sure what that number is or which investment options to choose, speak with your accountant or financial advisor.