Here’s what your 401k does—and why you need to start using it immediately
When journalist Katie Lobosco landed a gig at CNN in her mid-20s, she totally ignored her 401k.
Retirement? Ages away. Student loan payments? Breathing down her neck.
“Why would I voluntarily kiss goodbye a bigger chunk of my paycheck while I'm still paying off a student loan and paying expensive New York City rent?” she says.
It took her a whole year to enroll. By then she had cheated herself out of nearly $24,000. “I was throwing away money by NOT contributing more to my 401k,” she later found out.
The thing is, a lot of people are starting their careers with the same mistake. Statistically, today’s twenty-somethings are less likely than any other generation to pay into a 401k. Many don’t even know what one is. (If you’re one of them, keep reading. You’re about to save yourself a stack of money.)
A 401k is a retirement account most full-time and some part-time employees get as part of their job benefits package. It gives you the option to dedicate part of your paycheck each month for your retirement savings. Over the years, your money grows as it earns interest. It even follows you from job to job, like a faithful sidekick.
A lot of young workers put off starting their 401k because they feel broke. Student loan payments alone are enough to stretch an entry-level salary. But even if you don’t think you can’t afford it, do it anyway. Here’s why:
You’ll get free money.
Does your employer make matching contributions? Many will match up to 50 percent of your 401k payments, up to a certain percentage. That means for every dollar you pay, your employer adds 50 cents. You’re basically getting paid to save.
By saving 6 percent of your salary, you could end up making an extra 3 percent income. For Katie, that would have meant earning an extra $1,704 a year, which could have grown to more than $20,000 by the time she retired.
If you’re not getting matching contributions on your 401k, you might as well be using dollar bills to line your trashcan. Starting even one year earlier can net you as much as $51,758 in extra retirement savings over time.
It’ll have more time to grow.
You’ve got 40 years or so to save for retirement. That might sound like a good excuse to put it off. But it’s an even better reason to start now.
Why? Because compound interest. When you pay into your 401k, you earn interest not only on your contributions, but also on the interest you’ve already earned. Compound interest really makes your money snowball—and the more time you give it, the bigger your snowball grows.
Let’s say you make $40,000 a year and contribute 10 percent of your income to your 401k. If you wait until age 30 to start, you’ll end up with around $617,000 by retirement age. But if you start when you’re 22, you’ll end up with more than $1 million. That’s the power of compound interest.
You’ll pay less in taxes (for now).
Feeling too cash-strapped to save? Here’s a fun fact: Contributing to your 401k actually lowers your taxable income, so you’ll pay less in taxes for the time being.
That’s because your contributions are tax-deferred, which means they’re taken out of your paycheck before your employer calculates your tax withholdings. You won’t have to pay taxes on your 401k savings until you start taking withdrawals. For now, that means a break on your taxes when you need it most.
You can take it with you.
Maybe you don’t plan on cooling your heels long in your current job. Maybe you’ve already got your eye on your next gig. No worries—your 401k will follow you wherever you go. Anytime you leave your job, you can roll over your savings to your next employer or transfer it into a private investment account.
Even if you’re broke, your 401k is still one of the best things you can possibly spend money on right now. Start today, and stop throwing away free money!