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One of the essentials of financial freedom is preparing for the future. One way you can do this is by opening a tax-advantaged retirement account. One of the retirement accounts you can open is the 401k.
401k: The Basics of What You Should Know
A 401k is a retirement account that comes with tax advantages. You hold certain investments in the account, and they have the potential to grow over time. In 2011, you can contribute up to $16,500 to your 401k. If you are over the age of 50, you can contribute an extra $5,500 on top of your regular contribution to catch up.
If you have a regular 401k, your contribution is pre-tax, meaning that you get a tax deduction that lowers your income, resulting in a lower tax bill during the year. Your earnings are tax-deferred, which means that you don’t have to pay taxes on them until you start withdrawing from your account. Understand, though, that there are income phase-outs associated with your tax-deductible contribution. The 401k also comes in a Roth version. With a Roth 401k, you contribute after-tax dollars. You don’t get an immediate tax benefit, but your earnings grow tax-free “ you won’t have to pay income taxes on your withdrawals.
Why Maxing Out Your 401k Contributions Is Smart
Before you open another type of investment account, it can be a good idea to max out tax-advantaged retirement accounts. This will give you maximum tax benefits as you set aside as much money as possible for the future. If your employer offers a matching program, you can get free money. Even if you decide that you want to put some money into an IRA before maxing out your 401k, you should at least max out your employer match. An employer match represents free money that the employer puts in for you. Be aware, though, that many employers have a vesting period; you lose the employer contribution if you leave your job before a certain period of time.
Maxing out your 401k can mean that you have that much more money set aside, as well as savings in terms of tax liability.
Use Supplemental Income to Max Out Your 401k
One way to earn enough money to max out your 401k is to make use of supplemental income. Look for ways to earn a little more money now, and put it toward maxing out your 401k. Many people, even with the matching contribution from an employer, have a hard time maxing out a 401k each year. You can make a plan to increase your contributions with the help of extra income. If you contribute $150 a paycheck, and you are paid every other week, that’s 26 pay periods a year, and $3,900 a year in your contribution. If you want to max out the 401k, you will need an additional $12,600.
This means that you need $1,050 a month extra in order to max out your 401k. Work toward building up that amount, either by getting a part-time job, or by starting a side hustle. You can also work on monetizing a web site, or build up a dividend portfolio. It might take a few months, or a couple of years, to get to the point where you are making an extra $1,050 a month, but it’s doable. Create a plan to max out your 401k now, and your future self will thank you during retirement.