START CONTRIBUTING TO A TAX-FAVORED RETIREMENT SAVINGS PLAN
3. Start Contributing to a Tax-Favored Retirement Savings Plan
You may be scared to part with your money right now, or you may just think retirement is so far away, why bother? But here’s the reality. Saving money in a retirement plan is one of the smartest things you can do when you’re young. If you’re lucky enough to work for a company that offers a retirement savings plan like a 401(k), you should take advantage of it. There are several reasons to participate in a 401(k). For starters, many employers will match a portion of the amount you put into such a plan. That means the company will contribute a set amount—say, 50 cents—for every dollar you contribute, up to a specified percentage of your salary.
That’s free money, equivalent to an immediate 50% return! (In fact, if your company offers such a fabulous matching deal, you should probably contribute to the plan even before paying off your credit card debt.) In addition, the federal government allows you to delay paying taxes on the money you contribute to a retirement savings plan until you withdraw that money. That translates into an immediate tax break of hundreds of dollars each year. If, for example, you contribute $1,000 to a 401(k), you will reduce your taxable income by $1,000. If you’re in the 25% tax bracket, that’s a savings of $250.
Be forewarned that you’re going to hear horror stories from people who lost huge amounts of money in their 401(k)s. But the benefits of matching and tax-deferred growth are so huge that this is still the best deal out there. And, if you’re really nervous, there are ways to invest in your 401(k) without losing any of the money you contribute. (Learn all about this in Chapter 6).
Although you won’t be able to withdraw your money until you reach age 59½ without paying a penalty, many plans allow employees to borrow against their retirement savings at favorable rates. If you switch jobs, you may be able to move your 401(k) money into your new employer’s plan (or transfer it into something called an individual retirement account; see below).
Your employer might have already signed you up for its 401(k). If not, contact your employee benefits office and ask how you can have a set percentage of each paycheck automatically transferred into your company plan. Many companies allow you to do this online. Try to at least contribute the maximum amount for which you’re eligible to receive matching funds.
If you aren’t lucky enough to work for an employer who offers a 401(k) or a similar company retirement plan, you should start investing in an individual retirement account (IRA). The most you can contribute to an IRA as of 2009 is $5,000 annually; if at all possible, contribute the maximum amount every year.
IRAs don’t provide matching contributions, so putting money in an IRA is somewhat less pressing than enrolling in a company sponsored plan that offers a match. Also, unlike a 401(k), an IRA does not permit borrowing. That said, certain IRAs known as Roth IRAs do offer a special benefit: You are allowed to withdraw the money you contribute to them at any time. (You’re not allowed to withdraw the interest you earned on the money you contributed until after you turn 59½.)
Bottom line: Max out your company’s 401(k) up until the matching limit if you have one. If not, go with an IRA.
Crib Note #4: Build an emergency cushion using an automatic savings plan