The Earlier You Take Advantage of Your 401(k), the Better

A young woman puts money into a piggy bank.

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If you saw a $5 bill lying on the sidewalk, would you pick it up? Assuming you didn’t see or know who dropped it, I think it’s safe to say that many of us would pick up the cash and be happy for the bit of good fortune.

Yet, according to a 2023 report from the U.S. Department of Labor, despite nearly 70% of U.S. private industry workers having access to employer-provided retirement plans, just 52% choose to contribute to one. With many of those plans offering employer-matching contributions, many Americans are leaving that proverbial $5 on the ground week after week — and short-changing their retirement.

With elevated inflation and uncertainty around the national economy, saving for retirement may seem like a luxury or a long-term goal. But whether you’re 22, 52 or even 62, there’s no time like the present to get started, and you can’t afford to miss out. For those who have access to it, a primary vehicle to get you to a financially stable retirement is the employer-sponsored 401(k) plan.

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Popularized in the early 1980s, 401(k)s have largely replaced defined benefit pension plans as the primary source of employer-sponsored retirement savings accounts in the United States. They’re imperfect in that they’re dependent on what you contribute, have associated fees and contribution maximums, and their value is subject to the ups and downs of the markets. But 401(k)s can encourage you to save more for retirement through a few features:

Forced savings. Contributions to your 401(k) are deducted from your paycheck before you have access to them
Tax-deferred. Those contributions are made pre-tax. Taxes are instead assessed on withdrawal
Employer match. Many employers will match your contributions to a 401(k) up to a certain percentage (typically 3% to 6%)
Compound interest. Your 401(k) will earn interest over potentially many years or decades

The power of time

The last point is the most important and what makes saving in a 401(k) such an important privilege. While it’s never too late to start contributing, you can’t ever make up for the years that you don’t participate. Even smaller contributions over time can compound to make a meaningful difference in retirement savings.

Let’s take the example of a $300 monthly contribution to a 401(k) account, a projected retirement age of 65 and a rate of return of 7% (based on historical averages). If you were to make that monthly contribution beginning at age 25, you would have more than $700,000 in your 401(k) at retirement. That number drops to just $340,000 if you start contributing at age 35 and to just more than $147,000 if you begin saving at age 45.

The IRS allows individuals to begin contributing up to $30,000 annually toward a 401(k) at age 50 to help catch up as retirement approaches. It’s a good feature to supplement an existing retirement saving plan, but it shouldn’t be counted on to fully make up for lost time. In the above scenario, if you waited until age 50 to begin saving for retirement in a 401(k), you’d need to contribute more than $2,300 per month just to accrue that same $718,000 that you would have reached by making a smaller monthly contribution starting at age 25.

Everyone’s ability to contribute to a 401(k) is different, and the above scenario does not take into account pay raises, market fluctuations or employer matches that can change your contribution levels or your account’s total value over time. But it’s an important illustration of the potential power of time in growing your savings no matter your contribution level.

What you will need

A 401(k) is a powerful tool to help you build a nest egg, but it probably shouldn’t be your only plan to provide income in retirement. Since 401(k)s are taxed at withdrawal, it’s also good to explore options such as a Roth IRA, which takes post-tax contributions but allows for tax-free growth and tax-free qualified withdrawals — and there are no required minimum distributions (RMDs).

Your lifestyle and income needs in retirement will be unique to you. Additionally, the cost of living, markets and tax policies will continue to evolve. That means there is no magic number to point to as “enough” for your retirement savings. Talking with a financial adviser can help you determine what the right level of contribution to a 401(k) is for your financial circumstances and income needs both pre- and post-retirement.

A 401(k) is a helpful path to a comfortable retirement that is available and underutilized by many during those prime earning years. There’s a $5 bill on the ground in front of you. There’s no time like the present to pick it up.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Rich Guerrini is the President and Chief Executive Officer of PNC Investments. In his role, he is responsible for all sales, operations, risk and compliance activities for the retail investments organization. Prior to his current responsibilities, Guerrini was Executive Vice President and Managing Director of Alternative Investments for PNC Investments and was responsible for development and rollout of the PNC Investment Center and PNC’s web-based investment offering.