So you just got a new job or promotion with a fat, shiny paycheck? How should you allocate your riches? According to most financial experts (and any fiscally sensible saver), you should maximize your contributions to a 401K. They recommend this because, even if your company does not offer a matching amount, this strategy provides a fairly simple way to automate your savings while also lowering the amount you pay in taxes.
Despite these advantages, there are many who neglect the advice. To understand why maxing a 401K is a good thing, the negative aspects must be understood first. One of the major reasons a 401K is not funded to the maximum that people shy away from having such a great deal of money tied up in long term (very long term) investments.
Usually, the maximum allowable amount is a high percentage of your gross income (as much as 30-40 percent), and, for those just entering the work force, this is a lot to let go. To overcome this, make a budget of your necessary expenses, and you’ll see that there is probably enough left over.
Another reason why some shy away from maxing out is that there is sometimes only one open enrollment period. This means that once they’re in the plan, they cannot back out, and the money being taken out of the individual’s paycheck every month is put away whether they need the money that month or not. This can be overcome by creating an short-term or medium-term emergency fund that can be drawn from in times of need.
Now that we’ve dealt with the negatives, what are the positives? Saving for retirement in a 401K creates periodic, enforced savings. The money you put away is being backed by the federal government, meaning there will be money available when it is time for retirement.
Another major advantage for maxing out a 401K is the resulting decrease in federal income tax. Generally about 25-30 percent of your paycheck is taken from your gross income and paid toward your federal income taxes. Money contributed to your 401K is taken out before income takes, so the full of value of this portion of your paycheck can earn investment interest.
Having money in a 401K also opens up options for future investment strategies. Once money has adequately matured in the 401K, it can be used to buy stock, invest in money markets, or find other long term investment opportunities. This money should be grown in safe, steady investments so that will be waiting when you’re ready to retire.
Deciding whether or not to max a 401K can be a difficult choice, especially if you are just entering the workforce. Though costs may be high in current economic times, planning for the future is always the right thing to do. Maxing out your 401K is the best way to get the most out from your paycheck in a safe and legal way.