You could save hundreds of thousands toward retirement this way.
- Graham Stephan believes the 401(k) is one of the best tools for building wealth.
- He’s correct about that, as 401(k)s help you reduce taxes while saving for retirement, and many employers match your contributions up to a certain threshold.
- Talk to your employer to see if it offers 401(k) plans and to set up yours.
Financial influencer Graham Stephan recently shared what he thinks is one of the “greatest drivers of wealth creation.” He’s referring to 401(k) plans, which are employer-sponsored retirement plans where you can save for retirement through automatic deductions from your paycheck. These plans allow you to invest in stocks, bonds, and sometimes other assets to grow your money.
The average 401(k) balance shows just how powerful this tool can be. Americans 65 and older have an average of $279,997 in their 401(k)s. If you have an opportunity to contribute to this type of retirement account, it’s a smart choice.
Why a 401(k) is one of the best ways to build wealth
There are two big benefits of 401(k)s that make them great for building wealth:
- Tax savings
- Employer 401(k) matches
Traditional 401(k) plans offer tax-deferred earnings. You’re allowed to deduct your 401(k) contributions on your taxes. This lowers your taxable income. You don’t need to pay taxes on the money in your 401(k) until you withdraw it.
Some employers also provide the option of opening a Roth 401(k), which offers a different kind of tax savings. With a Roth 401(k), you pay income taxes on contributions when you make them. However, your withdrawals in retirement are tax-free.
Many employers also offer what’s called a 401(k) match. This is when your employer agrees to match your 401(k) contributions, up to a certain amount. For example, one common matching structure is $0.50 of each $1 you contribute on the first 6% of your salary.
Let’s say you make $50,000 per year and your employer offers this type of 401(k) match. You could max out the offer by contributing $3,000 annually to your 401(k). Your employer would then add in $1,500.
Graham Stephan says that “the rule of thumb when your employer offers a 401(k) match is to always take it, no matter what,” and he’s right. It’s effectively free money, and it’s an easy way to boost your retirement savings.
How to save for retirement with a 401(k)
If you don’t have a 401(k) yet, the first thing to do is see if your employer offers one. There is also an option for self-employed workers with no full-time employees, called a solo 401(k).
Talk to your employer to see its 401(k) plan options and check if you’re eligible. Employers sometimes have eligibility requirements, such as completing one year of service. Once you’ve confirmed you’re eligible, there are a few things to do to set up your 401(k).
If your employer offers both a traditional 401(k) and a Roth 401(k), you’ll need to decide how you want to allocate your money. You may want to split your contributions between the two. That way, you have some tax-deferred contributions through the traditional plan, and tax-free withdrawals through the Roth plan.
Next, decide how much you’re going to contribute. If your employer offers a 401(k) match, try to at least contribute enough to max this out. Also, keep in mind that there are annual 401(k) contribution limits. The 401(k) contribution limits in 2023 are $22,500 for those under the age of 50 and $30,000 for those age 50 or older.
Last but not least, pick what you’re going to invest in. Investment options depend on the plan provider. 401(k) plans typically offer a selection of mutual funds. Other fund options, such as target-date funds built for a specific retirement year, may also be available.
It doesn’t take too long to get your 401(k) ready to go. One last thing to remember is to avoid withdrawing money from your 401(k) until retirement. Withdrawals before the age of 59 1/2 have a 10% early withdrawal penalty, and taking out your money early means it won’t have as much time to grow. You’ll get the best results by contributing regularly and only tapping into your 401(k) after you retire.
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