Stop fearing free money! Time to start your 401K.

Whether it is fear or doubt, stop throwing away free money. Time to understand a 401K plan and the benefits it offers for retirement.

If you walked past a $100 bill crumpled and dirty on the ground, would you pick it up?

Safely guessing here… most people, outside of the billionaires of the world (but most likely even them too), would probably stop, pin it with their foot, dust it off and stash it in their pocket. It’s free money. Lying there. And all it takes is a moment of your time.

So why do we fear 401K plans so much that we walk past this “free money” every day? Maybe it’s a fear of the unknown like turning a corner in a pitch black house after hearing a noise downstairs. Maybe it’s a fear of understanding 401K plans because we were told “you are never going to use this again” by other students after taking high school math classes. Maybe it’s a fear of prioritizing our retirement when so many bright billboards flash the newest and greatest at that moment.

After talking about the benefits of a 401K plan, I have even been told…

“I have other things to take of right now.” “I don’t have room for it in my budget.” “I don’t trust 401Ks.” “I have kids.”

For a while, I too ignored my 401K plan. I focused on paying off my debt. It seemed more simple. Pay it off first. Then save for retirement. And almost half of working Americans today use these reasons and more to pass on the “free money” that a 401K plan offers.

There are 160 million Americans eligible to work in the United States. Of those 160 million, 65% or 104 million of them have access to a 401K plan. And this number will only increase as pension plans disappear and social security reaches a breaking point.

Yet only 55 million Americans have enrolled in their company’s 401K plan… 47% of working Americans turn down the free money that a 401K plan offers… 47% lose out on the tax breaks, the matching funds, the passive investment gains, and the compounded interest.

Even the 55 million Americans enrolled in the plan do not use it to the fullest extent. Vanguard, one of the largest 401K plan providers reported the current averages per age group below:

Age GroupAverage 401K Plan Balance
Under 25$4,048.00
65 and older$200,358.00

Retiring with $200K in your 401K Plan and using the 4% rule (where you take out 4% of your total funds each year to live in retirement) means that you will have $8K each year to spend in retirement per year! That is not going to cut it.

Now if you put money into Social Security for 35 years at the maximum amount, then you could potentially receive another $33K per year to spend. But to receive the maximum amount, you would have to put in the maximum amount… and this is placing a lot of trust in an institution that could see struggles in the year 2034, if not earlier (just google “when social security runs out of money”).

This is where the 401K plan can be utilized. Don’t leave your retirement in the hands of the Social Security. In order to alleviate the fears and the doubts of a 401K plan, let me first define it.

A 401K plan is a (1) company-sponsored retirement account to which employers can make (2) matching contributions and the (3) earnings build up on a (4) tax deferred (until a later date) basis.

Yeah… that’s a mouthful. So I figure I need to break down this definition a bit further…

(1) Company sponsored retirement account -> an account offered by the company you work for allowing you to save up to $19k each year for retirement, as of 2019.

This is an account offered by your company. Not offered by the government. And you can put up to $19K each year in it. If you put $19K a year in your retirement account for 20 years at the average growth rate of the S&P 500 (more on this in a moment), then you could potentially have $933K. Even if you put away $10K each year, the potential growth could be to $491K after 20 years. And these numbers don’t include the potential matching contributions.

(2) Matching contributions -> companies will oftentimes match any funds that an employee puts into their 401k plan.

For example a company could offer a 50% match up to 8% of the employee’s salary. If an employee saves 2% of their salary, then the company would add 1% of their salary in the 401K plan just for saving.

Your company pays you to save for retirement through the matching funds. Why not take advantage of it? I raised the roof like Michael Scott for my match, thinking that I just got myself a raise for doing no extra work.

(3) Earnings build up -> any savings put in the 401K plan will have the ability to be invested in a company-selected group of index, mutual, bond, or target retirement funds that have historically grown over time, building wealth for those 401K plan holders.

Allowing your savings to grow over time creates the greatest amount of free money. There are many options to invest, but my favorite are index funds. By investing the money in index funds, you are purchasing a small piece or stock of each business in that fund at a very low cost.

For instance, if you bought an S&P 500 index fund, then you would be buying a small portion of each of the stocks in the S&P 500. The index fund would then track the price increases or decreases of each stock in the S&P 500, and thus increasing or decreasing the money you invested in that index fund.

To give you some history and perspective, on March 1, 1979 the S&P 500 was 101.59, and over the last 40 years the S&P 500 has climbed to 2,791.52, averaging an annual increase of 8.64% each year on price alone.

Does this mean that these increases will continue to occur? Not necessarily, but the track record continues to speak for itself. Over the last 40 years, there have been 5 major stock market crashes, so these gains have weathered those and still returned some impressive results. For example, if you invested $10K in an S&P 500 index fund 40 years ago then you would have $274K today. I’m thinking $264K of free money sounds pretty good to me.

(4) Tax deferred basis -> Currently two 401K plans exist that offer tax deferrals:

(A) in a traditional 401K plan, money will be transferred to the account tax free, be allowed to grow tax free, and only be taxed when you take out the money from the account (although there are a lot of tax breaks available to minimize those taxes when you take it out), and

(B) in a Roth 401K plan, money will be transferred to the account after income taxes, be allowed to grow tax free, and be tax free when you take out the money from the account.

The tax breaks on the traditional or Roth 401K plan also make the decision to access your company’s 401K plan a must. You can save on income taxes now or save on taxes later, depending on your plan choice of (A) or (B) above, but as Yoda would say “save on taxes, you will.”

With a little better understanding of a 401K plan, hopefully you understand how it plays a key role in any retirement, especially since you can put $19K into the account each year, receive tax breaks on that money, and even earn matching funds from that company… and this is all while the money can be invested in vehicles that can grow it to much greater levels.

If you have access to a 401K plan, try to do whatever you can to sign up for it and save as much as you can. At a minimum, save enough to earn the full match the company offers.

And if you’re still hard pressed to overcome your fears, then do yourself a favor. Take a picture of yourself and a picture of your parent or grandparent and put it side by side (heck, if you really want to go all out, there are actually apps that can take a current picture and change the image to what you will look like when you’re older). When those fears, and doubts, and other priorities rear their ugly head, think about your future self. Are you making decisions that will help both your current self and your future self?

Look at those two pictures… and allow your current self to stop… pick up that $100 bill lying on the ground.. and put it in your 401K plan. Do it for your future self!

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