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What does 'saving for retirement' mean to you?
Your answer might change depending on your age:
20's - I'm still working on my career. I'm young, why do I need to save for retirement now?
30's - I'm finally making good money, and I need to buy XYZ (a house, a car, have kids, ect)...I can save later.
40's - Wow, I don't have much saved. I should really start saving for retirement...is it too late?
It is never too late to start investing for retirement, but the earlier you start the better. The first thing you should think about when "saving for retirement" is that, you actually do not want to save, but you need to invest. And one of the easiest ways to invest for your retirement is through your employers 401k plan.
The 401k Plan
The 401k plan allows you, as an employee, to contribute a portion of your pre-tax (Traditional) or post-tax (Roth) income to a specific investment account designated by your employer. You can then use your contributions in your 401k account to invest in stocks, bonds, and mutual funds - which is meant to help grow your money faster than if you were to only save your money.
One of the pros to contributing to a 401k plan is that your employer will likely match a percentage of your contributions, which can significantly boost your overall investments.
However, the cons include the yearly contribution limit, which does gradually increases every year and is currently at $23,000 for 2024. There are also withdrawal restrictions and early withdrawals penalties.
Traditional 401k vs Roth 401k
Before we get to the withdrawal restrictions, lets touch on the main difference between the Traditional and Roth 401k plans. It's only recently that employers began offering the Roth 401k plan, so not all companies may offer this option. However, if you are offered both options, it is possible to contribute to a Traditional and Roth 401k plan, as long as the total contributions to both stay within the yearly maximum (ex. $10k in Traditional and $13k in Roth).
Traditional 401k
Traditional 401k contributions are made on a pre-tax basis. This means that your money is deducted from your salary before income taxes are paid.
Simplified Example (Annual):
Gross income $100,000
Pre-tax 401k contribution = $23,000
Income that is taxed = $77,000
Net income (after taxes and 401k contribution) = $56,500
Although you save on taxes now, withdrawals from a Traditional 401k plan will incur ordinary income taxes later!
Roth 401k
Roth 401k contributions are made on a post-tax basis. This means that your money is deducted from your salary after income taxes are paid.
Simplified Example (Annual):
Gross income $100,000
Net income after taxes = $70,000
Post-tax 401k contributions = $23,000
Net income (after taxes and 401k contribution) = $47,000
Although you get taxed now, withdrawals from a Roth 401k plan is tax free later!
Knowing your retirement strategy will help guide you in deciding where you put your money, either a Traditional, Roth or both!
Withdrawal Restrictions
I highly encourage you to understand the withdrawal rules and restrictions for any investment accounts you choose to put your money in. Here are a few rules with withdrawing from a 401k plan:
Age Restrictions:
Generally, withdrawals from a 401k before the age of 59½ may be subject to a 10% early withdrawal penalty, in addition to income taxes.
There are some exceptions to the early withdrawal penalty, such as for certain medical expenses, first-time homebuyers, or qualifying disabilities.
Required Minimum Distributions (RMDs):
Once you reach the age of 72 (or 70½ if you turned 70½ before January 1, 2020), you are required to start taking minimum distributions from your 401k known as RMDs.
The RMD amount is calculated based on life expectancy and the account balance. Failing to take the required distribution may result in penalties.
Tax Implications:
Withdrawals from a Traditional 401k are generally taxed as ordinary income.
Withdrawals from a Roth 401k are tax free!
Invest for your Future
How much money will you have SAVING vs INVESTING starting at age 25?
Using $22,500 yearly maximum
8% investment return
Using a compounding interest calculator: my go to calculator
AGE | SAVING | INVESTING | Difference between SAVING vs INVESTING |
25 | $0 | $0 | $0 |
30 | $112,500 | $131,988 | $19,488 |
35 | $225,000 | $325,947 | $100,947 |
40 | $337,500 | $610,922 | $273,422 |
45 | $450,000 | $1,030,644 | $580,644 |
50 | $562,500 | $1,644,883 | $1,082,383 |
55 | $675,000 | $2,548,872 | $1,873,872 |
60 | $787,500 | $3,877,128 | $3,089,628 |
See how 'saving' your money could cost you thousands, maybe even a million!
Summary:
A 401k plan is one type of investment account
You may have the option of contributing to a Traditional, Roth or both 401k plans
Contributions will be deducted from your income and automatically added to your 401k account
While your money is automatically moved to your 401k account, you still need to invest those contributions and pick your stocks, bonds, and mutual funds
There is a yearly maximum that you can contribute, which is $23,000 for 2024
Know the withdrawal rules and restrictions with your 401k plan!
Don't save for your retirement, INVEST in it!
It's Never too Late to Invest for your Future
Maxing out your 401k starting at age 40 can still yield over $1.5 Million by 65
*Using $22,500 yearly maximum, 8% investment return
AGE | SAVING | INVESTING | Difference between SAVING vs INVESTING |
40 | $0 | $0 | $0 |
45 | $112,500 | $131,988 | $19,488 |
50 | $225,000 | $325,947 | $100,947 |
55 | $337,500 | $610,922 | $273,422 |
60 | $450,000 | $1,030,644 | $580,644 |
65 | $562,500 | $1,644,883 | $1,082,383 |
Let me know if you learned something new or what topic you'd like to learn more about in the comments!
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