Should you contribute to your 401(k) at work? The short answer is yes. Unless you absolutely cannot afford to set aside any dollars whatsoever, you should contribute to your employer’s 401(k) plan. A 401(k) plan is one of the most powerful tools you can use to save for your retirement.
The first benefit is that your pre-tax contributions to a 401(k) plan are not taxed as current income. They come right off the top of your salary before taxes are withheld. This reduces your taxable income, allowing you to pay less in taxes each year. You’ll eventually pay taxes on amounts contributed when you withdraw money from the plan, but you may be in a lower tax bracket by then. You may even qualify for a partial tax credit for amounts contributed.
Furthermore, money held in a 401(k) plan grows tax deferred. The investment earnings on plan assets are not taxed as long as they remain inside the plan. Only when you withdraw those earnings will you pay taxes on them (again, possibly at a lower rate). In the meantime, tax-deferred growth gives you the opportunity to build a substantial 401(k) balance over the long term, depending on investment performance.
If you’re lucky, your employer will match your contributions up to a certain level (e.g., 50 cents on the dollar up to 6% of your salary). You typically become vested in your employer’s contributions and related earnings through years of service (the details depend on the plan). Employer contributions are also pre-tax and are basically free money (once you’re vested), so you should try to take full advantage of them. If you fail to make contributions and receive no match, you are actually walking away from money your employer is offering to you.
Finally, 401(k)s are a very convenient and reliable way to save. You decide what percentage of your salary to contribute, up to allowable limits. Your contributions are deducted automatically from your paycheck each pay period. Because the money never passes through your hands, there’s no temptation to spend it or skip a contribution here and there. Most plans allow for contributions as small as 1% of your pay.
Ready to get started or increase your salary deduction? Contact your human resources department or plan representative.