Explaining the Benefits of a 401(k) to Young Adults Entering the Workforce
If you have a young adult in your life entering the workforce, they may have the opportunity to open up a 401(k) through their new employer. In some cases, that employer will also offer matching contribution funds up to a certain percentage. While it sounds like a no-brainer to take advantage of these benefits early, many younger employees do not participate in their employer's 401(k) plan.
It’s essential to help the young adult in your life see the benefit of saving early and often to set them up for success in the future. Here are some key benefits of starting to contribute to a 401(k) in your early 20s.
Potential Employer Contributions
One of the most important reasons to start participating in a retirement plan early is employer contributions. Every employer is different, but many will offer some type of matching contribution for those who choose to participate in their sponsored retirement plan. Employer contributions are essentially “free money” for your child’s retirement savings.
Say your young adult's employer will match contributions one-to-one for up to 4% of their paycheck—anything they contribute up to 4% will be doubled. In this scenario, they should aim to contribute at least 4% of their paycheck in order to take full advantage of what many people consider to be “free money.”
Not only is opening a 401(k) a smart idea, it’s also very easy to contribute to one. Contributions are taken from their paycheck pre-tax and deposited directly into their retirement account. If they start saving early on, they probably won’t even notice a difference in their take-home pay. Most 401(k) plans also make it easy to automatically increase contribution rates each year—something that many financial professionals suggest to effectively compound retirement savings.
Compound Interest Can Mean Comfort in Retirement
The earlier your young adult starts to save, the more likely they’ll be able to comfortably retire when they get older. Compound interest builds over time, so the longer their account is open and funded, the greater potential for substantial growth. And starting now will allow them to build a good habit of saving a little bit every month. Even if they stop contributing because of unemployment or financial strain, the money they’ve already contributed has the ability to continue to grow.
Retirement Plans Offer Tax Breaks
Another engaging reason to start participating in a retirement plan early is the tax breaks that come with it. Every young person remembers the feeling of getting their first pay stub and seeing a large percentage of their pay taken out for taxes. By participating in a 401(k), your young adult can save money before those taxes are taken out. The money they put away now has growth potential due to compound interest and will not be taxed until they begin taking distributions from their account during retirement.
For some individuals, contributing to a Roth IRA or Roth 401(k) could also present a fantastic opportunity. Younger workers likely are eligible to contribute to a Roth account until their incomes reach the phase out levels. If your younger worker is in a lower tax bracket then they will be later in life, it may be a good opportunity to plan for the future and contribute to a Roth account.
Alternative Options for Retirement Plans
If your young adult's employer doesn’t offer a sponsored 401(k) plan, they can consider an IRA plan instead. IRA plans offer similar benefits to traditional 401(k)s—they gain interest over time, can take automatic contributions from paychecks and involve tax benefits. Your child can choose from a traditional IRA, which is tax-deductible, or a Roth IRA, which is not tax-deductible but has the benefit of non-taxable distributions during retirement. Since these are independent plans, your child can keep them open even if they start a new job that offers a 401(k). Many financial professionals even recommend keeping retirement savings in more than one type of account.
Whatever career path your young adult chooses, saving for retirement is an important step in setting themselves up for success.
This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2021 Advisor Websites.