Why You Should Invest in Your 401(k)
Even if retirement isn't in your immediate future, saving and investing now can help you live comfortably after you're done working. One of your most impactful opportunities to save, and potentially grow your savings, over time is by investing in your 401(k). You may be familiar with some of the benefits, from employer contributions to reduced taxes. But did you also know that your savings have the potential to compound over time, which may generate additional income for retirement?
If automated, tax-advantaged savings sounds appealing, here are five more reasons to consider contributing to your 401(k):
1. 401(k) Contributions Are "Before-Tax" Money
With a traditional 401(k), your contributions are deducted from your gross income. In other words, tax-deductible contributions are removed from your paycheck before taxes are applied. Taxes aren't deducted from your contributions or any investment earnings in that account until you withdraw the money.
2. When You Finally Pay Taxes on Your 401(k), It May Be at a Lower Rate
A 401(k) can offer meaningful tax advantages. Since traditional 401(k) contributions are made before taxes, they don't count toward your taxable income, which may lower your tax burden for the year.
Although you'll pay taxes on the income you withdraw from your traditional 401(k) later on, some savers may be in a lower tax bracket once retired and making withdrawals — though this depends on individual circumstances and isn't guaranteed. If you have a Roth 401(k), you contribute post-tax money to your account, which means qualified retirement withdrawals are generally tax-free.
3. Your Employer May Contribute to Your Retirement Plan
One advantage of an employer-based 401(k) is that it's a convenient way to start saving for retirement. Not only are your contributions automatically deducted from your paycheck, but your employer may also choose to make matching contributions, up to a certain amount. Any contribution your employer makes is additional savings toward your retirement.
Depending on the type of 401(k) you have (Roth or traditional), you'll owe taxes on funds either before they're added to the account or when you withdraw the funds.
About 401(k) Contributions
A 401(k) is a defined contribution plan that allows you and your employer to make contributions up to a specific dollar amount set by the IRS. This contribution limit changes annually to account for inflation, and higher catch-up limits apply for certain age groups. Check the current IRS limits for your age group before planning your contributions.
One way to get the most out of your 401(k) is to consider maximizing your contributions, up to the amount permitted. If your company offers matching contributions, you may want to explore taking full advantage of this benefit.
Beyond annual contributions from you and your employer, your account may also earn a rate of return, though returns are not guaranteed and account values can fluctuate, including the potential to lose value.
4. Assets Generally Protected From Most Creditors
In the event of bankruptcy or issues with commercial creditors, your 401(k) assets are generally protected under the Employee Retirement Income Security Act (ERISA), which prevents most creditors from reaching qualified retirement plan assets.
There are notable exceptions, however. ERISA's protection does not extend to the federal government: the IRS can levy a 401(k) account to collect unpaid federal taxes, and courts can also order a portion of retirement assets divided for child support or alimony through a qualified order. These exceptions apply regardless of who technically holds the assets in trust, so it's worth understanding that 401(k) savings are not shielded from all types of claims.
5. Your Money Has the Potential to Compound
Compound interest refers to interest calculated on your original contribution amount, plus any interest that has already accumulated on it. Depending on your plan's terms, compounding may occur daily, monthly, quarterly, or annually. Over time, this compounding effect — combined with continued contributions — may increase your account's growth potential, though actual results will vary based on market performance and are not guaranteed.
Investing involves risk, including the possible loss of principal. Investment returns and account values will fluctuate. There is no guarantee that any investment objective will be achieved.
