If you work for a company that offers a 401(k) plan, you can almost certainly afford to contribute to the plan.
I know, it can be easy to think that you can’t afford to contribute, what with all the bills and whatever else is going on in your life right now, but you probably can.
And you almost certainly should, if your company offers a match. (At least up to the match amount, if possible.)
Let me give an example. Suppose you make $30,000 per year, and the minimum contribution to your 401k plan is 1%. One percent is $300, which might seem like a lot when you think of all the other things that $300 can buy. But on the other hand, $300 compared to the amount of money you imagine you might need in retirement seems like a drop in the bucket. So why bother?
Well, two reasons.
One, $300 taken out pre-tax does not equal you bringing home $300 less per year. In fact, you probably won’t even notice much of a difference at all in your paycheck. That’s because pre-tax contributions to a traditional 401(k) plan reduce your marginal tax rate.
That’s important because…if (for example) you’re single with no dependents, instead of being taxed on $30,000 per year at a marginal tax rate of 7.60%, you would be taxed on $27,700 per year at a marginal tax rate of 6.98%.
In English, you’d be paying $345 less in taxes. So…would you rather put money into your own pocket for the future, or give the government more money?
And two, $300 per year over 30 years adds up to $15,429, even if you were to have a ridiculously low rate of return like 3%, never increase your contribution rate, and never ever get even the tiniest raise — all unlikely scenarios. Change that to a decent rate of return, add salary increases, gradual contribution increases, and a company match, and you’ll be talking big bucks in comparison.
So unless you’re in an unusual situation (and having bills does not constitute an unusual situation), contribute to retirement, keep contributing, and leave the money alone until you retire. You’ll thank yourself in the future.
Posted in Retirement on 05.25.10 with 9 comments.
Good post. I liked especially how you showed that contributing to your 401k can reduce your tax rate, using real numbers.
Some of the best advice I ever got was to contribute to my 401k immediately, with my first paycheck. Then you don’t get used to it, and budget without that money from the start.
I agree with Everyday Tips: “Some of the best advice I ever got was to contribute to my 401k immediately, with my first paycheck. Then you don’t get used to it, and budget without that money from the start.”
I agree with you both. Start things out right, and not only will you never know what you’re “missing” by not having that money in your check, but you’ll be gaining a whole lot.
I started contributing to my 401k 90 days after I started my job as required. That first hit of 6% hurt, but I haven’t noticed it since…I don’t notice my Roth IRA contributions either…
Hehe, I notice my Roth contributions, because I transfer the money over manually, but having money come out of my check automatically is painless.
This is an argument I have had with some coworkers many times….. I JUST DON’T understand how people can be so shortsighted!
Great post!! I contribute 12% and just started an IRA at $150 a month… Not much, but I have a lot of loans to pay off!
I think maybe they just really don’t understand it. It can be confusing, and often the benefits aren’t explained all that clearly when the information is presented. But yes, people are often shortsighted.
Absolutely on point. Every time I thought I couldn’t contribute more, I still bumped up my contribution. In a matter of months, I didn’t even notice it.
Pay yourself first, asthey say, but utilize that 401K as well.
Gradual increments are the key. We get used to things, so we can leverage that to our advantage.