Wealth in America is growing! You’ve read this and probably thought, “yea, this is obvious,” but I’m referring to 401(k) balances. According to a Fidelity Investment analysis, 401(k) balances have grown 9.6% since last year and the average 401(k) balance is $97,700!
In the past year, American households have contributed $5,850. Even though this is better then the previous year, there is still room to grow with contributions since you should be maxing out the $18,000 contribution limit. However, lets look at this from a glass half full perspective; people are taking their retirement contributions more seriously and this is a strong indication of continued growth in wages and in the overall economy!
If you feel left behind by these statistics , are a newbee to 401(k)s, or you’re not taking advantage of your employer’s matching benefits, I’ve got you. Here are the basics you need to know to understand how this type of retirement/investment account can help you in retirement.
In most cases, 401(k)s are offered by employers. I advise every single person to take advantage of the 401(k). Some employers offer a match for the amount you save and some employers offer profit sharing. THIS IS LITERALLY FREE MONEY! So consider this, you have potential growth on the investments you have based on the funds and diversification of your portfolio, AND your employer may match contributions, AND may even give a gift if they approve profit sharing distributions to their employees.
Here are some other points to know about a 401(k):
- Pre-tax contributions. When you get your pay stub, you’ll see that your contributions are pre-tax deductions. In other words, if your gross pay is $2,000 and you contribute $200 to your 401(k), you’ll get taxed on $1,800 as opposed to the gross $2,000. By contributing to your 401(k), you are reducing your taxable income.
- Un-taxed growth. As you select your investment strategy for the funds in your 401(k), the gains in your retirement account are not taxed. Hold that thought, because you will eventually get taxed…
- Contribution limits. as of 2017, you can contribute up to $18,000 a year and up to $24,000 if you’re older than 50. The higher contribution limit past 50 years old allows you to catch up as you approach retirement.
- Rollovers. If you leave your job, you can rollover your funds to an IRA or your next employer’s 401(k) plan.
- Taxes. Here it is…Once you retire and begin to withdraw funds from your 401(k), you will begin to pay taxes. Since you were not taxed in the front end, Uncle Sam will grab his share in the back end of the equation. But don’t worry, this whole time your money has grown tax free!
Now, what many are not aware of is that there are 2 different kinds of 401(k) accounts. Roth and Traditional. To keep this very simple, Roth 401(k) contributions are taxed upfront, and you don’t have to worry about paying taxes during retirement. Whereas, the traditional 401(k) does not tax during the contribution but you are taxed when you begin to withdraw in retirement. Pick your poison.
In those circumstances where an employer doesn’t offer 401(k) plans, there is an option for you to consider…
This type of account is neat because it’s designed for a business owner with no employees. In other words, you can be a sole proprietor (one man shop) and all you need is an employee identification number which is easily attained by the IRS. Hmmm…
- Contribution limits. With this account, you can contribute up to $54,000 a year, with an addition $6,000 in contributions if you’re older than 50. Sounds like a sweet deal.
- You can select either a Roth or Traditional solo 401(k). Once again, pick your poison.
- The only exception to having no employees is if your spouse works for the company and earns an income from the business. Meaning, your spouse can make contributions and the company can make profit sharing contributions.
So if you’ve got your own business or you are planning to begin a new venture, this is a great option for you!
The bottom line is to make the 401(k) a serious component of your life. Financial planning can be boring and not interesting for some of you, but the decisions you make now can make a world of a difference during your retirement. Make that investment in yourself and do everything you can to contribute the maximum contributions on a yearly basis.