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401(k) Basics: It’s Never Too Early to Save for Retirement

401(k) Basics: It’s Never Too Early to Save for Retirement

Although it might seem too early for college students to plan for retirement when most haven’t started working full-time yet, understanding the retirement savings basics can help you make smart financial decisions that will pay dividends for decades.

A 401(k) is one of the most common retirement savings plans, and you should consider enrolling as soon as you start working.

Here are a few basic facts about 401(k)s.

What’s a 401(k)?

Named after a provision of the IRS legal code, 401(k)s are retirement savings accounts many companies use instead of a traditional pension plan. A traditional 401(k) plan allows you to invest a portion of your pre-tax income in an account where the savings can grow. Once you reach age 59.5, you can begin withdrawing the money, and pay income tax on it then. Another option some companies offer is a Roth 401(k) which is funded with post-tax earnings and withdrawals in retirement are tax-free.

Many employers will invite you to enroll in the company’s 401(k) plan when you start working there, and some may enroll you automatically. There’s no fee to participate, and you can choose how much you want to contribute each pay period.

Why you should participate

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Your 20s are the ideal time to start saving for retirement. On the most basic level, starting a savings habit early will help you maintain that practice throughout your life. That’s good enough of a reason on its own, but the structure of 401(k) plans provide financial incentives for early saving as well.

The first benefit is the employer match. Many employers match some portion of their workers’ contributions, and the more you deposit, the more your employer may match. The employer match essentially gives you free money, and by not contributing, you’ll miss out on these additional funds.

The second benefit is compound interest. As with any savings account, funds contributed to a 401(k) earn interest. With each investment cycle, new interest is added onto the previous total. With more cycles for your interest to compound over time, you’ll see greater growth.

The beauty of compound interest is that it allows you to save a smaller amount per pay period at a younger age and still end up with more money by retirement than a person who contributes more per pay period but doesn’t start doing so until later in life. Put some numbers in this compound interest calculator to see the benefits of early saving.

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401(k) tips and tricks

Because young adults have plenty of financial obligations — from student loan debt to basic living expenses – saving for retirement can fall low on the financial priority list.

That’s understandable, but remember, you can contribute as little as 1% to your 401(k), and because funds are deducted from your check before you get paid, you won’t feel the financial pinch as much. Although it’s advised to contribute enough to get the full benefit of your employer’s matching funds, you can put in less if that’s all you can afford now. Just make sure to increase your contribution as soon as you’re able to.

401(k) contributions also reduce your taxable income, which can help quite a bit when tax time rolls around. As long as you don’t withdraw money from the fund, you won’t pay any income tax on money you contribute.

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Save today, enjoy tomorrow

Free money, tax breaks, compounded interest and a simple way to save for retirement – a 401(k) account has it all. As you begin your job search, make sure to look into a potential employer’s 401(k) plan and sign up once you land the job.

Even if you don’t put in much at first, those small contributions and matching funds multiply quickly. You’ll be surprised how much you can save in just a few years and be quite pleased with the nest egg you’ve built by the time you retire.

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