There’s no doubt that saving for retirement can seem like herculean task; especially when you’re just starting out. But the good news is that there are many tools available that make your savings process easier – and help you save more.
At the top of the list are employer-sponsored 401k plans and IRAs, both of which offer tax advantaged ways to build your retirement nest egg. But how do you know which of these is best for you? The answer is simple: If you have access to a workplace 401k, start saving there. Then use an IRA to boost your savings even more.
Why You Should Prioritize your 401k
Employer sponsored 401k plans first became available in the late 1970s and by 1982, nearly half of all the large employers offered such a plan or were considering offering one, according to the Employee Benefit Research Institute.
Today 401ks have become a pillar of American retirement savings, constituting $3.6 trillion in assets. As we show in the Daily Capital article, Defined Contribution Plans on the Rise: Action Required, they’ve grown faster over the last five years than any other retirement plan type, including IRAs, pensions and other defined benefit plans.
A 401k provides three primary benefits relative to other retirement accounts:
- Free money. Most importantly, the vast majority of employers who offer a retirement plan provide some sort of matching contribution. Read on for an example of a typical common match – 50 cents for each dollar the employee contributes, up to 6 percent of their pay – and its impact on an investment portfolio.
- Higher contribution limits. With a $17,500 contribution limit, you can save significantly more in a 401k than an IRA. There’s also a catch-up contribution of $5,500 per year if you’re over 50. IRAs have annual contributions caps of $5,500 per year, and $6,500 if you’re over 50.
- Automatic savings – that stay with you. You can accumulate savings without having to worry about remembering to make deposits – your contributions are deducted before you ever see your paycheck. And unlike some other workplace plans, you get to keep the assets if you leave the company.
Don’t Leave Money on the Table
Your employer match is essentially free money, and the primary reason you should start saving with your workplace 401k first. Let’s take a look at an example of how that small amount of added saving can make a big difference in the long run.
Caroline is a 30-year-old who makes $100,000 per year and saves 6% of her salary in a 401k that has no employer match. Let’s assume her salary grows at the rate of inflation. At that rate, investing with a 6% real return, she’d accumulate $87,000 in her 401k over the course of 10 years.
Now, let’s say Caroline switches companies and her new plan has a 50% 401k match policy. That totals another 3% of her salary in contributions. Now, her savings rate jumps to 9% annually and that match garners her an extra $43,000 over the same time period. Over 30 years, the benefit of that employer contribution – combined with the magic of compounded interest – is even more impressive, accounting for $340,000 in additional savings.
Use an IRA to Save More
Once you’ve maxed out your contributions to your workplace 401k, consider saving more for retirement with an IRA. The chart below, which we made for the post Roth IRAs and 401ks: Are They a Smart Move for You?, will help you compare the tax benefits of each IRA with 401k plans.
Saving for retirement doesn’t have to be intimidating. In fact, your workplace retirement plans not only make beginning to save easy, they may also offer some free money that will jumpstart your efforts.