For many employees, a company 401(k) – or equivalent retirement plan – is one of the most valuable benefits they receive – but it’s also one of the benefits people are most likely to overlook. Whether you are 25 or 55, contributing to your employer’s retirement plan can be an important step toward building financial security.
For younger workers, the most important thing is simply to get started. When you’re in your 20s or 30s, retirement can seem so far away that saving for it doesn’t feel urgent. But time can be one of an investor’s greatest advantages. Money invested early has decades to potentially grow through compounding. Even relatively modest contributions, made consistently over a long period of time, can become significant.
Younger employees should also take advantage of an employer match when one is available. If your company matches a portion of what you contribute, failing to contribute enough to receive the full match can mean leaving part of your compensation on the table. For example, if your company matches 6% and you only contribute 4%, you’re missing out on an additional 2% from your employer. That adds up over time!
Older workers shouldn’t assume that it’s too late to participate. If retirement is still several years away, there may be a meaningful opportunity to build additional savings through payroll contributions. Many plans also allow employees age 50 and older to make additional “catch-up” contributions, subject to annual IRS limits. For someone approaching retirement, increasing contributions may be one of the most effective ways to strengthen their retirement income plan.
Another important decision is whether to use traditional or Roth 401(k) contributions. Traditional 401(k) contributions are generally made with pre-tax dollars, which can reduce your taxable income today. Taxes are generally paid when the money is withdrawn in retirement. Roth 401(k) contributions are made with after-tax dollars, meaning you pay the taxes today, but qualified withdrawals in retirement are generally tax-free.
Neither option is automatically better for everyone. Your current tax bracket, expected future tax rate, income, retirement plans and overall financial situation should all be considered. Some employees may even benefit from using both options to create tax diversification in retirement.
It’s also important to remember that a 401(k) is an investment account, not a guaranteed savings account. The investments inside the account can rise and fall in value. That makes diversification important. Rather than concentrating your retirement savings in one company, industry or type of investment, spreading your money across different asset classes can help reduce the impact of a downturn in any single investment.
For employees who aren’t comfortable choosing their own investments, a target-date fund can be a useful option. These funds are designed around an approximate retirement year and generally invest more aggressively when retirement is farther away. As the target date approaches, the fund typically becomes more conservative. While target-date funds are not risk-free and aren’t right for everyone, they can provide a simple way to maintain a diversified portfolio without having to constantly make investment decisions.
Perhaps the most important lesson is this: don’t wait for the “perfect” time to start contributing. Start with what you can afford, increase your contribution when your income rises, and periodically review your investment choices and retirement goals.
Your 401(k) may not feel like a priority today, but years from now, those regular contributions could become one of the most important parts of your financial future. I know retirees who didn’t contribute to their company’s 401(k) while they were in the workforce – and all of them wish they had a time machine so they could go back and participate. Don’t miss the opportunity.
Tracy L. Campbell is a partner and financial advisor at Meriwether Wealth and Planning, an independent Registered Investment Adviser (RIA) firm headquartered in downtown Minden, La. E-mail Tracy at tracy@meriwether.com. Disclaimer: This content is for general knowledge and education, not a substitute for professional advice.