people know they should invest for the future, but at least half
would like to do better. In a Salary.com poll about investments
in the company retirement plan, 44 percent of respondents said they
contribute, but could do better; 13 percent know they should invest,
but have other priorities; and 41 percent said they contribute the
maximum. Just 3 percent reported not having a retirement plan.
you're gainfully employed and reasonably satisfied with your career,
there are few good excuses for not taking advantage of this benefit.
If you've got access to a company 401(k), 403(b), or other plan,
make friends with it now, and you'll thank yourself later. Here's
not saving, it's investing...
401(k)s and related plans exist to let you invest part of your salary
before you or the IRS can get near it. To participate, you, the
employee, agree to set aside a fixed percentage of your gross (pretax)
monthly salary. In many cases, your employer will reward your efforts
by kicking in an additional 25 cents to a dollar for every dollar
you contribute. This free gift is called the "company match," something
employers do to encourage workers to save, or as part of their general
benefits program. They get a tax incentive from the government to
do this, because the government wants people to save for retirement.
The company match is like an immediate return on investment.
now, pay tax later...
As your contributions build, so do investment earnings, with no
taxes due until retirement. This is a far better prospect than a
taxable investment because earnings compound without frequent withdrawals
to pay for interest, dividends, and capital gains taxes. Ultimately
Uncle Sam does get his cut, but much later, when you close the investment
out, which you can only do after age 59 1/2.
Say a person who is single, age 25, and earning $3,000 a month opts
to invest 5 percent of it, or $150, in the 401(k). Uncle Sam only
taxes the remaining $2,850. Then, if the employer matches 50 cents
on the dollar, the $150 swells by $75, bringing the monthly contribution
up to $225. That's a $2,700 investment per year, money which could
otherwise burn a hole in that new pigskin wallet. This person has
deferred paying $337 in taxes for the year.
gets even better, because of interest. If your investment earns
10 percent (the things that have an impact on your return will be
discussed in Part 2), that's $270 in interest for the year. Of that,
$90 is interest on the employer matching contribution and $34 is
interest on money that you otherwise would have paid in taxes. So
that's four sources of free money: employer match, tax savings,
interest on employer match, and interest on tax savings. And we
haven't even talked about compound interest.
investment for a lifetime
Invest, then leave the money alone. If you withdraw money any earlier
than age 59 1/2, you are charged a 10 percent "premature withdrawal
penalty" before you've paid a penny of ordinary income tax. But
if you leave it alone, you will have a solid source of income after
you stop working. Social Security could provide some help, but it
is no guarantee, and it is unlikely to cover all of your retirement
the example above, if the person has been contributing $150 a month
for a year with a 50 percent employer match, and continues to contribute
at exactly that rate until 2045, the year of retirement, the account
will be worth close to $2.2 million in 2045. (This assumes an inflation
rate of 3.5 percent, an annual yield of 10 percent, and an effective
tax rate of 18 percent, and a few other things.)
are you: grasshopper or ant?
401(k)s are only for long-haul investing. If you're planning career
suicide by trekking to Nepal in search of your inner Yak, don't
put money in here. It'll cost far too much to break it out when
you need it. In your worst financial drought, you might be able
to negotiate a loan with the 401(k) plan manager, but only if you've
built up enough time and assets.
case you haven't heard Aesop's fable of the Ant and the Grasshopper
in a while, here's how it goes.
One fine summer day, a grasshopper was hopping through the field,
cheerfully singing grasshopper songs without a care in the world.
Along came an ant, lugging an enormous ear of corn toward the ant
"Come over hear and sing with me," said the grasshopper,
"instead of working so hard. It's a beautiful day."
The ant replied, "I am helping to store food for the winter,
and suggest you do so as well."
"Who can think about winter on a day like today?" asked
the grasshopper. "There's plenty to eat right now." But
the ant continued its heavy labor.
When winter came, the grasshopper had nothing to eat, and was very
hungry. But the ants had plenty of corn from what they had stored
away over the summer.
Then the grasshopper knew: It is best to prepare for the days of
Audrey Arkins, Salary.com contributor-Modified 11-15-2004