401(k) savings plans have become the staple of retirement savings for the majority of Americans. As the defined benefit pension plan (in which an employee’s pension payments are calculated by their length of employment and salary at the time of retirement) decreased in popularity with employers, they were largely replaced by another product, the 401(k) defined contribution plan. The merits of each program aside, it is evident that a significant shift has occurred in retirement strategy, one that puts the savings burden on the employee rather than the employer. With the burden shifted to you, the employee, the question begs:
Are you fully maximizing the potential of your 401(k) plan?
401(k) plans are relatively simple in structure. To participate, the employee chooses to defer a portion of their regular pay (usually expressed as a %) for future retirement, and the employer deposits this money into a savings plan for investment. With the exception of Roth-style deferrals, most 401(k) savings are “pre-tax,” which means contributions are taken out before they are taxed as income. The tax liability is not dismissed, only deferred until retirement. At that time, any funds withdrawn from the account are taxed as ordinary income.
During the work years, some employers contribute to their employees’ 401(k) savings by providing a matching contribution. 401(k) matching contributions are considered part of an employee’s overall compensation and can be a significant boost to a lifetime of savings. For example, if John voluntarily defers 6% of his salary into his corporation’s 401(k) savings plan, the company may pledge to match 50% of each dollar for a total of 3% match. Over a career, the additional contribution combined with employee deferral can grow to a large sum.
Many people who currently participate in their company 401(k) would consider this the end of the discussion. Sign up for the 401(k)? Check. Contribute enough money to maximize the company match? Check. But stopping here would mean missing an opportunity to take full advantage of this savings strategy’s potential. And it has a lot of potential.