If you are like many Americans, you have that one burning question on your mind: "Will I be financially stable when I get ready to retire?" A good place to start in answering "yes" to this question is with an employer-sponsored 401(k) plan.
A 401(k) can be described simply as a retirement savings plan that is funded with pre-tax earnings from the employee and, depending on the company, the employer may offer a matching contribution or make a "profit sharing" contribution.
The first benefit of this sort of retirement plan is that it allows the employee to save for retirement.
Secondly, management fees on these types of retirement funds are typically lower than can be found by single investors due to group discounts.
The most important part of any retirement plan is time, which allows for the magic of compounding interest. This is where interest is earned on interest rather than just the initial principal, generating significant returns over time.
Consider this example. An employee is able to put just $1,000 a year into a 401(k) retirement account. This is about $83 a month, or about $40 every two weeks. Because it is pre-tax, and assuming a 20% withholding rate, this becomes only $800 in actual "take home" pay per year.
If we assume a retirement age of 65 and an 8% annualized rate of return, someone who is 55 years old has a 10-year window for their investment to grow. They would put $10,000 into the plan and would walk away with $14,487. Using the same assumptions, a 45-year-old would invest $20,000 and retire with $45,762. A 35-year-old would invest $30,000 and retire with $113,283. A 25-year-old would invest $40,000 and retire with a staggering $259,057.
This example is for illustration purposes only and is not a guarantee of any past or future performance.
Clearly time is your friend regarding retirement funds and compounding interest. While the 25-year-old's investment was only $30,000 more than the 55-year-old's, the end account size was over $240,000 higher.
A good way to begin saving is to contact your employer and explore your options. In most cases contributions come out of your paycheck automatically, and because they are pre-tax the impact on your take-home pay may not be enough to notice.
If you get periodic raises from your employer, a good idea might be to increase your retirement contributions at that time so your take home pay is unaffected but you begin to save more each paycheck.
It may not seem like much, but small differences can mean hundreds of thousands of dollars when it comes time to retire.
Casey Waddell is a business banking officer at Baker Boyer Bank and a member of the Blue Mountain Asset Management Coalition.