Why Should You Contribute To Your 401K?

Before reacting to the question, why contribute to your 401k, let’s first answer the question. What is a 401k?

A 401k is a retirement savings plan with associated tax benefits provided by your employer. A 401k is only an account into which you, principally, and your employer (perhaps) secondarily both contribute.

The money that you contribute is always yours and can never be forfeited due to a change in your employment status. You can, however, lose money on investments, but leaving your job won’t cause you to lose your hard earned money.
There is for two types of 401k accounts, “traditional” and “Roth.” Many, but not all, employers offer both.

1. Traditional: Traditional 401k accounts offer a tax deduction for contributions. Withdrawals will be taxed when withdrew during retirement.
2. Roth: Roth 401k accounts do not offer a tax deduction for contributions, but the withdrawals during retirement are not taxed at all.

While many people get excited about the idea of the Roth—no income tax during retirement—the value of that difference is confined to the difference in tax rate between now and retirement. If you have low enough income—or enough children—that you pay little or no tax on your income now, then it makes perfect sense for you to assist with the Roth type account. If you have high income as some do at the pinnacle of their careers, it may make more sense to contribute to a traditional account to shelter income in the high tax year and pay tax in retirement when income may drop you into a lower tax bracket.

The fundamental reason is to assist in your 401k, regardless of which account type you choose, is to save money for your retirement. Investment returns for the current generation are liable to be lower than in the previous generation, meaning that we’ll need to invest more than our parents to have the same sort of retirement. More than ever, we need to use the benefit of what the financial world calls “compound returns.” That simply means, we need to go to the benefit of the interest on the interest piling up over the years to predict our retirement.

The secondary factor to assist in your 401k is that your employer is probably needing to get to contribute to the account. If you contribute $1,000 this year, your employer will likely give you another $500 to $1,000 as well. The money contributed by your employer is typically subject to vesting, meaning that if you leave within a defined period of time, you’ll lose the money the company contributed on your behalf and the earnings on it. Still, that means that you could get a raise just for contributing to your 401k—which you should do anyway. It’s basically free money. Never miss out on free money!