Stick with me while I try to explain this seemingly difficult concept in the simplest of terms and give you the tools to figure out your situation.
You’ve heard the pay yourself first mantra, right? Well, how about letting your employer pay you second?
For conversation purposes I am going to use the following example, none of the numbers are real but hopefully they are good, round, and easy to understand:
- Income – $1,000 per month
- Tax rate – 20%
- Employer will match up to 4% contribution
- Current contribution – 2%
- 401k return – 5% annually
AT 2% CONTRIBUTION: As it sits you bring home $784 per pay period. You and your employer contribute $40 ($20 each) to your 401k each month for a total of $480 per year. You make $11.15 in interest (at 5%). (Go here for a free 401k Calculator for Excel. It’s free.) Your 401k balance at the end of one year is $491. Your 401k balance at the end of 10 years is $6,211 and you’ve made $290 in interest.
AT 4% CONTRIBUTION: As it sits you bring home $768 per pay period. You and your employer contribute $80 ($40 each) to your 401k each month for a total of $960 per year. You make $22.31 in interest (at 5%). Your 401k balance at the end of one year is $982. Your 401k balance at the end of 10 years is $12,423 and you’ve made $579 in interest.
Let’s see $12k or $6k after 10 years? I know that you’re thinking, “but I just don’t have another 2% to put into my 401k right now.” My answer is, “you CANNOT afford not to.” I want you to get the most for you money. This is seriously the easiest way to do it!!! And since 401k contributions are generally taken right from your paycheck you probably won’t feel much of a hit.
The difference in take home pay in the example above is $16. A $16 cut in pay for an extra $40 (the additional $20 contribution and $20 match) per month!
I hope that you are still with me and that all of this has made sense and that you aren’t totally overwhelmed with numbers. PLEASE leave me a comment if you have a question or shoot me an e-mail. I am not an expert, but more than happy to help you!
More on *managing* your 401k coming soon.
P.S. That link I provided for the 401k calculator (Vertex42) is an awesome financial resource if you are a do-it-yourselfer. There is a bunch of different calculators to help you figure out pretty much anything. Mortgage, savings, loans, 401k… AND IT’S TOTALLY FREE!!!
P.S.S. Do you know how to save money on your energy bill?