If your company offers a 401(k) plan and you’re not participating, there are many reasons why you should start. Let’s begin with one rather sobering reason:
Your Social Security payments alone aren’t going to be enough to finance your retirement.
Social Security payments, though a wonderful thing, almost certainly won’t be enough to sustain your current lifestyle (unless you already live in poverty). Social Security payments can be under a $1,000 per month or, often, between $1,000 and $2000. Will a monthly payment of, say, $750 be enough to maintain your current way of life? Will even $1,200 or $1,500 be enough? Will you be able to do more than meet your monthly expenses and buy a little food, let alone travel and see your children and grandchildren? Remember, with inflation, your $1,200 or $1,500 won’t have the purchasing power that it has now.
Besides, some of the experts, including the head of the federal government’s General Accounting Office, are now saying that Social Security may not even be around 20 or 25 years from now if nothing is done to fix. The retirement of the baby boomer generation, they explain, will put a huge stress on the system.
But let’s suppose that something is done and Social Security is saved. We should then take full advantage of it; after all, we pay into it out of each paycheck we earn. But it is best to consider it a supplement, not the mainstay of retirement.
Participating in your 401(k) may make it easier for you to live now.
In modern American life, one of the biggest expenses is taxes. We pay federal and (in many states) state income taxes, property taxes and sales tax. Some cities, in addition to property taxes, car titles and other assessments, even add an income tax of their own.
401(k) plans were set up so that you can contribute to your retirement on a pre-tax basis. That means that, until you retire and start to collect 401(k) payments, you will not pay any taxes on the funds contributed. At that time, many experts point out, your income is likely to be lower, and so you’ll pay less tax overall.
So if you start contributing to your 401(k) plan now, your taxable income on your next federal return will be less than it would have been otherwise. You will save on your federal (and state) income taxes.
The 401(k) plan program (the name comes from the section of the tax code in which it appears) was purposely set up with this tax benefit to encourage people to save for retirement.
If you participate, you may be able to increase your current compensation.
Most companies no longer offer retirement pensions to their workers, so 401(k) plans may be the main (or even only) retirement benefit that they offer. The kind of retirement benefits they can offer the most highly-compensated employees may depend on how many of the “rank and file” participate in their 401(k) plans, so they are motivated to make 401(k) plans as appealing as possible.
To encourage more people to participate (and, of course, to help their employees), companies may provide an employer match as an incentive. For example, your company may match 100 percent of, say, the first 4 percent you contribute to your plan.
Do you feel like you’re under-compensated? Would you like to get a raise? You can increase your compensation immediately by starting to contribute 4 percent to the plan. With your company’s match, it will be like you just starting contributing 8 percent to your retirement. Of course you won’t receive this compensation immediately, but over your entire career with your company you could increase your compensation considerably. (If you go to a new company, you’ll probably be able to “roll it over” with you, or you may keep it with the third party administrator that your company uses.)
You may also, after you have built up a big enough balance, be able to borrow from your 401(k) plan. Generally, such loans are paid back through paycheck deductions, and may include special terms (such as a longer repayment term) for those who use the loan to buy a home.
401(k) plans are generally pretty safe investments.
Companies have no desire to be liable for Enron-like disasters, so 401(k) plans are generally safe as milk. For one thing, your company cannot administer your 401(k) plan itself and has no access to the funds contributed to the plan. 401(k) plans must be administered by a third party, generally a company that specializes in such things. So if your employer goes bankrupt, your 401(k) plan won’t, unless you invested entirely in your company’s stocks (which would be rather unusual).
Under 401(k) plans, funds are invested in stocks and securities. Although no stocks are 100 percent safe, most investments in the typical 401(k) are going to be pretty safe. There’ll probably be a mix of very safe but low-yield investments, with some higher-risk but potentially high-yield investments. The administrator’s 401(k) notifications and educational materials should explain which is which.
Despite a certain amount of risk, you’re better off investing in your 401(k) than you are in doing nothing. For many people, their 401(k)s can become their major asset. If you start soon enough, your 401(k) can be your road to a comfortable retirement.