You probably know the general idea of how a 401(k) works: Your employer regularly takes part of your paycheck and puts the money into your account where it’s invested in the funds you’ve chosen. You leave it there for a while, your investments increase in value, and then you sell them in retirement to reap the profits.
The chance to grow your wealth is undoubtedly the biggest perk of owning a 401(k), but it’s not the only one. Here are three other benefits you might not have considered.
1. You can reduce how much you need to save for retirement
Many employers offer a 401(k) match as an employee benefit to attract talent, and if your company does this, you should do all you can to claim it. An employer match reduces the amount you personally need to save in order to reach your retirement goal. This can leave you with more spending money today, or it could help you retire earlier than you’d be able to if you were saving all on your own.
There’s still time to claim your 2022 match if you haven’t already. Check with your company’s human resources department to learn how much more you need to contribute to claim your full match for the year. Then, divide this by the number of paychecks you have left this year to see how much you need to withhold from each check. Try your best to save the full amount if you can before the end of the year.
Start planning for 2023 as well. Figure out how much you must set aside to get your full match next year and make sure you’re contributing at least enough to your 401(k) throughout the year to claim it.
2. Your contributions reduce your taxable income
Most 401(k)s are tax-deferred, which means the money you put into these accounts reduces your taxable income for the year. So if you earned $50,000 this year and put $5,000 in a 401(k), the government would treat you as if you only earned $45,000, reducing your tax bill.
But that doesn’t mean you’re totally off the hook with the government. Once you withdraw money from your 401(k) later on, you’ll have to pay taxes on your contributions and your earnings. This could be more costly unless you expect your income to drop significantly between now and retirement.
It’s also worth noting that Roth 401(k)s have different tax rules. These accounts are growing in popularity because they offer tax-free withdrawals in retirement. But they don’t give you the same upfront tax break that traditional 401(k)s do.
If your company offers both, you could split some money between each type of account or save in just one. But remember you’re only allowed to contribute up to $20,500 to 401(k)s in 2022, or $27,000 if you’re 50 or older. This limit applies to all your 401(k) accounts combined, not to each one individually.
3. Your savings are protected against creditors
The Employee Retirement Income Security Act (ERISA) ensures that creditors can’t come after your 401(k) funds if you owe money or if your employer declares bankruptcy. Not all retirement accounts offer this protection. Hopefully, you’ll never need to use it, but it’s nice to know you have it anyway.
ERISA doesn’t protect you from all types of creditors, however. If you owe an ex-spouse or the IRS, you might still have to fork over some of the money in your 401(k), but this is uncommon.
This should give you more incentive to save in your 401(k) if you have access to one. If you’re not able to save much right now due to inflation and the upcoming holiday season, start planning for 2023 instead. Think about how you could rearrange your budget and how much you can afford to set aside out of each paycheck for retirement. Then, put your plan into action once the new year rolls around.
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