Not Participating in Your Employer’s 401K Program Can Cost You in the Long Term
Keith L. Rucinski, CPA, JD Chapter 13 Trustee
You have started a new job. The human resource department sent you a stack of paperwork. Among the paperwork is a form asking if you want to reduce your take home pay by putting retirement funds into your employer’s 401K retirement program.
You have bills to pay. Your student loan payment is due. Your rent is due. You are trying to save up for a car. You cannot afford to reduce your take home pay and save for your retirement.
Actually, you cannot afford not to save for retirement.
Most private employers today do not have traditional pension plans, whereby the employer fully funds their employee’s retirement and guarantees monthly payments to the retired employee. Today, employers most often offer their employees a 401K program.
In a 401K program, employees must contribute a portion of their wages to the program. The employee contributions are made from gross wages prior to taxes being deducted. This allows the 401K contributions to reduce taxable wages from the pay check you receive today, thereby reducing the taxes you pay at the present time.
Note: When funds are withdrawn they are taxable, but as funds are not meant to be withdrawn until retirement, less tax is paid on those funds under the assumption your retirement income puts you in a lower tax bracket than when you were working.
Most 401K programs allow employee contributions of three percent to six percent. Lets assume you make a contribution of three percent. If your gross pay is $600 a week, you would contribute $18 to the 401K program ($600 x 3%). The employer would match the $18, thus you would have $36 in your account.
When you are beginning your career, $18 can seem like a lot of money when you are on a tight budget. However, with proper budgeting, for instance, packing your lunch one or two days a week instead of ordering from the nearest fast food restaurant, can help you come up with the funds. Note: your retirement and waistline will thank you in the long term.
Over forty years you would contribute $37,566 and your account would be worth $184,744 ( assuming employer matching, and a four percent rate of return compounded quarterly for forty years). If you chose not to contribute you will have zero in your retirement account.
Remember, as your income increases, so will your contributions, employer matching, and interest. Many people retire today with high six figure retirement accounts because they contribute to their retirement program on a regular basis.
Other things to consider:
401K programs often offer participants to borrow against their funds at below market rates. The funds are then repaid by future wage deductions. However, when you take out the loan against your 401K funds there are less funds in your account that are invested and earning investment returns. In the long term, loans can greatly reduce the amount in your account when you retire.
If you change jobs during your career, remember to take your 401K funds with you. Your new employer will often allow a “rollover” of those funds. The funds have to be transferred (rollovered) from the old employer to the new employer 401K program. If you cash out the funds, all those income taxes being deferred become due in addition to other tax penalties.
Over the course of your career, you may do some type of self-employment. You can still rollover your 401K from your old employer into some type of individual retirement accounts. This lets you keep your funds from your old 401K and allows you to be eligible to contribute to your new accounts as a self-employed individual.
When you are thinking about retiring, consult a financial and/or tax advisor to make sure you structure your 401K withdraws in a manner that limits your tax liability,
The longer you wait to begin contributing to your retirement program, the less funds you will have in retirement.