Prepare for Retirement by Starting a 401(k) Plan
How do you envision your retirement years? Regardless of your goals, retirement requires money — almost certainly more than you think! But Social Security rarely provides what most people want or need, and pension plans are not as common as they once were. So, if your employer sponsors a 401(k) retirement plan, seize the opportunity.
A 401(k) plan lets you save and invest a portion of your paycheck before taxes are taken out. Because you’re saving with tax-deferred dollars, you don’t pay federal or state income taxes on the money you save until you withdraw it, generally at retirement. At that time, you’ll likely be in a lower tax bracket than today. The interest on the money saved in the 401(k) grows tax-deferred.
How a 401(k) Plan Works
Many 401(k) plans allow you to choose how to invest your money. Most plans offer an array of investment vehicles: mutual funds composed of stocks, bonds, and money markets. Investment gurus often advise to diversify your money among stocks, bonds, and money markets to mitigate risk.
Usually, you must work for your company a certain amount of time before becoming eligible to enroll in the 401(k) plan. Contributions come out of your paycheck automatically, making it effortless. Many employers will match workers’ 401(k) contributions up to a certain amount—often 3-6% of your salary. If you make $50,000 annually and defer 3 percent ($1,500) into your 401(k), your employer may match that up to another $1,500. Be sure to check the rules for contributions, including how much you can contribute each year. Matching funds, which become nonforfeitable when you’ve completed your company’s vesting period, can really help your 401(k) account grow.
You may begin withdrawing your 401(k) funds as early as age 59½ depending on the plan’s provisions.
Compounding Interest
Contributions to a 401(k) plan have the benefit of compounding interest: The interest you earn each year on your investment is added to your principal. Say you contribute $1,000 to your 401(k)—that’s the principal. If you earn 10 percent interest a year, your balance would be $1,100 at the end of the first year, $1,210 at the end of the second year, $1,331 at the end of the third year, and so on. You can see that with continued annual contributions—coupled with employer matching funds—your 401(k) account can grow over time.
By maximizing the amount of money you can contribute to a 401(k) each year, you take full advantage of compounding interest, as well as employer matching funds.
Take-Home Benefit
Because you fund your 401(k) with pre-tax dollars, your taxable income declines. This table shows how a 401(k) increases the take-home pay of a worker who makes $35,000 annually. By reducing the tax burden, that individual keeps $210 more of their salary than if they saved that money in a conventional savings account.
Without 401(k) With 401(k)
ANNUALIZED GROSS PAY $35,000 $35,000
401(k) 0.00 -1,750
Taxable Pay 35,000 33,250
Federal Income Tax (12%) -4,200 -3,990
FICA (7.65%) -2,678 -2,678
Conventional Savings Account -1,750 0.00
NET TAKE-HOME PAY $26,372 $26,582
A 401(k) plan is a great way to use your current financial resources to fund a secure future. Offering a 401(k) retirement plan may be the key to finding and keeping productive employees. Use Paychex’s unmatched retirement experience to work for your business and employees. ABA members receive a 25% discount on 401k admin fees.
To learn more, go to the Paychex Help Request Form or call 800-729-2439 (mention code 5712).
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