Sunday, February 24, 2013

Why you should max out your 401k contribution

First let me start off by admitting that I am not the biggest fan of the limited options that you have in an employer 401k. However there are many other advantages that I am going to go through in this post. Here are the top 3 benefits to maxing out your 401k:

1) Reduces your taxes. Contributions to a 401k are deducted from your pay before taxes are calculated. In 2013 the individual contribution limits are $17,500 or $23,500 if you are 50 or older. Not only will you not pay taxes on your contribution, but it may also put you in a lower tax bracket for the remainder of your income that will be taxed.

2) Free money with an employer match. Now most companies will not match 100% of the money you put in. But a typical match is 50 cents for every dollar you put in for up to 6% of your salary. So if you are making $100k a year your employer would match half of the first $6k of your contributions ($3k in free money from your employer).

3) Tax deferred growth. Since you don't pay taxes on your 401k money until you start pulling money out, your nest egg gets to grow tax free which allows your money to compound more quickly.

In my opinion these are very compelling reasons to max out your 401k and the earlier you start the easier it is. If you get use to this strategy early you wont miss the money.

Now I started this post stating the big elephant in the room. That is that you don't have that many choices of where you can invest your money. Most companies have a dozen or so different funds and a money market option.

I would typically recommend that you choose a broad market fund. But if you are super paranoid than just leave it in a money market fund. Also remember that you don't have to always be invested. You have the ability to move money between funds and the money market if you think the markets are in for a large decline.

Good Luck Trading!

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