Advantages of tax-sheltered deferrals
No matter what the size of your company, employees may enjoy the benefits of participating in a 401(k) plan. One of the most popular retirement plans around, a 401(k) is a proven way to save money for your golden years. Just consider the following features:
- Tax deferrals: No current tax is due on the amount of salary deferred to your 401(k) account. Contributions are made on a pretax basis. Therefore, you save tax on those amounts, plus your earnings, until you are ready to make withdrawals (usually after you have retired). This gives you plenty of time to build up a nest egg.
- Contribution limits: Although the tax law restricts the amount that can be deferred to your personal account, the limits are relatively generous. For 2015, you can defer up to a maximum of $18,000, or $24,000 if you are age 50 or older. These contribution limits are indexed for inflation each year.
- Matching contributions: Frequently, an employer will match a portion of your deferral, so there is an added incentive to participate. A common match is 50% of the first 6% of the amount you save. For instance, if your salary is $100,000 and you contribute 6%, or $6,000, to the plan, the employer may provide a matching contribution of $3,000.
- Convenience: Many people find that having money automatically deducted from their paychecks is easier than trying to save through other means. Some plans have an automatic enrollment feature to further encourage participation.
- Loans: The plan may permit you to borrow from your account for specific reasons, such as buying a primary residence, funding a child’s education, paying unexpected medical expenses or enduring a severe economic hardship. Generally, the loan must be paid back with interest within five years, although this time frame may be extended for a house purchase. The interest you pay goes right back into your own account.
- Investment options: Typically, you will have a wide range of investment options to choose from, including mutual funds targeted to your retirement date. You can allocate your investment dollars based on your particular circumstances, objectives and tolerance for risk. Consult a financial expert to tailor your allocation to your specific needs.
When should you start saving? The sooner, the better. However, even if you did not begin participating in a 401(k) plan until later in life, you can make up for lost time by maximizing your contributions. For example, suppose you are age 60 and have only six years until the normal retirement age to receive full Social Security benefits. If you are able to defer $24,000 each year to your 401(k), with a 50% company match up to 6% of deferral, and the investment earns 8% annually, you will accumulate an extra $198,902 for retirement in this short time.