The economy over the past two years has caused a lot of people to change some of their financial habits. Unfortunately, one of the areas where people have been cutting back has been in 401K contributions. The stock market took a big bite out of many people’s balances and many workers took that as their cue to stop investing. Now is a great time to be investing and your 401K should be one of the first places you’re putting money each month. There are several reasons why adding to your 401K is a wise financial decision:
- Contributions Are Tax Deductible: Reducing your taxable income this year means you pay Uncle Sam less in the form of taxes this year. This is especially important if you are in a high tax bracket and could use the tax breaks this year. Many employers also offer a Roth 401K, which allows you to pay taxes on your contribution this year but withdraw it tax free during your retirement after it has had years to grow and compound.
- Growth Is Tax Deferred: The interest, dividends, and capital gains that are amassed in a 401K each year are not taxable, so all of the growth is yours to keep each year. It will be taxed as ordinary income when you take it out, but the money you save by not paying taxes annually on the growth and income from your 401K is allowed to stay in your name and grow, adding up to a much larger amount in the end when compared to a taxable account.
- Stocks Are Cheap: It was definitely painful to watch the decline of the stock market during 2008, and even those who tried to hide from the carnage in bonds took a big hit to their portfolio value. The recovery over the past 5 months has been a refreshing change, but stocks still have a long way to go before they are back at what many consider their fair value to be. Although you can never predict the short term movement in the stock market, it’s safe to say that investors buying right now are getting shares at a substantial discount compared to just a few years ago. Over time, that discount should pay off.
- The Match Still Matters: It’s always a good idea to take advantage of money that your company is offering to invest in your behalf. The company match is one of the most important elements of any retirement plan. If the economy has you in a position where you have to cut back on your 401K contributions, at least try to contribute enough to take full advantage of the company match. Never leave free money on the table!
- Timing the Market is Impossible: Some people seem to think that they have a knack for predicting the future performance of the stock market, but very few can do it accurately. If you’re waiting to increase contributions again for that gut feeling to tell you that it’s the right time, you still could very easily be wrong. A better approach is to be disciplined and contribute to your 401K consistently in good markets and in bad markets. Over time, the winners will be those who steadily saved in their 401K regardless of market conditions.
