While my employment has changed slightly (new ownership) over the last few years, I've been with my new company for a little over 2 years now. When I was re-hired by my new company, one of the benefits that I was most excited about was the opportunity to participate in a company 401K plan. Prior to that, I had a trivial amount of savings and only contributed a little bit into my Roth IRA.
I started contributing to my first 401(k) account in October 2011.
Currently, any employee can contribute up to a maximum of $17,500 a year into their 401(k) or 403(b) if your employer offers it.
Wow, sounds like a ridiculous amount of money doesn't it?
When I first read about my 401(k) contribution limit of $17,000 (limit was lower in the past, recently increased to $17,500), I rolled my eyes and scoffed.
“I will NEVER be able to contribute THAT much.”
I didn't think I could do it, but I'm slowly getting closer to that $17,500 amount. It's been a slow and steady journey for me and my 401(k) these last 2 years. I started off with the measly, default 3% contribution rate. Then I slowly and regularly increased my 401(k) contribution rate by 1% to 2% at a time every few months.
Increasing my 401(k) contribution rate by a small percentage helped me slowly adjust our monthly budget. If I decided to max out my 401(k) right away, it would result in $1,458.33 less coming in per month ($17,500 / 12), not an insignificant sum.
Right now, I'm on track to contribute $14,040 from my own deferred salary and my company is generously contributing $3,240 per year from the match. This equals $17,280 worth of contributions each year into my 401(k).
I'm $3,460 shy of meeting my goal to max out my 401(k) annual contribution. I'm hoping that I will be able to finally reach this goal before the end of 2014.
Note: employer matching contributions do not count towards the maximum limits that you can contribute to a 401(k) plan. However, employer matching contributions are limited to 25% of your salary and the total of your elective salary deferral plus employer match is limited to $52,000 for the year 2014 and $51,000 for the year 2013. There are no income limits when contributing to a 401(k) / 403(b) workplace retirement plan.
What if the stock market crashes?!
Well, if you are young and in the accumulation phase of your portfolio, you should be excited that you can buy more shares of stocks for cheap. As an accumulator of wealth, you have the chance to buy more shares on sale when the stock market does poorly. If the stock market continues to do poorly, you continue to buy more and more shares for cheap.
The best part of investing with your 401(k) is that everything is done automatically and you are dollar cost averaging your investments along the way. Investment money is directly taken out of your paycheck and put to work for you. This is one of the easiest and most convenient ways to save.
Whether the stock market is doing well or poorly, money continuously flows into your account with each and every paycheck. A sudden drop in portfolio value actually benefits you.
Look at this graph of the S&P 500 from 1950 until today:
It sure would have been nice to buy some more stock index fund shares in 2009. While it is nice to see our investment accounts grow over the last few years, it hurts a little bit having to pay so much for each new share purchased.
The higher your tax bracket, the more pre-tax salary contributions you will want to make into your 401(k). You won't pay income taxes on the deferred amount. For example:
Let’s say you make an income of $100,000 a year and you invest $10,000 each year into your 401K. Tax on your income is now based on $90,000 and not $100,000.
You only pay taxes when you withdrawal from your 401(k) on or after you turn 59 ½.
While the goal of maxing out your 401(k) can be daunting, maximizing your Roth IRA contribution may be a more easily attainable goal. Starting in 2013, you can contribute up to $5,500 into your Roth IRA each year. $5,500 is a manageable savings goal amount that my wife and I have been doing the last few years.
I like to keep myself honest by posting financial updates from time to time. So far, our investment account balances have only been increasing. I'll be sure to share when our investments start to do poorly as well.
Here's a snapshot of my 401(k) balance after 2 years:
Here's a quick snapshot of our investment balance:
Have you started investing yet? See this retirement calculator here for motivation on how quickly you can accumulate wealth. You can read the beginning of my investment series here.
No matter how much money you make, the most important thing about investing is to save more by living on less than you earn, and investing the difference. The sooner you start investing, the easier it will be to reach financial freedom. I wish someone taught me about investing much sooner, I'm still playing catch-up.