What is a 401(K)?
A 401(K) is an investment account sponsored by an employer and regulated by the Government that enables an employee to invest $19,500 pre-taxed dollars per year.
The account grows tax-free (i.e. you don’t pay taxes on capital gains) and when you withdraw money, you pay taxes according to your tax bracket at that time.
You cannot withdraw money from your 401(K) until you’re 59 1/2 (and if you do, there’s a penalty).
Let’s put this into practice:
You earn $150,000 per year and you decide to carve out $19,500 for your 401(K)
When paying taxes the following year, you’ll pay taxes on $130,500, not $150,000
The full $19,500 is put into your 401(K) account (i.e. no taxes are paid during that time)
Let’s say you’ve ignored retirement planning and you’re 35 and want to start. Assuming a contribution of $19,500 per year and a return of 10%, you’ll have ~$2M by age 60:
The above scenario doesn’t even assume that your company matches. Most companies contribute 50 cents for every dollar employees contribute up to 6% of your pay. So here, assuming your salary stayed at $150,000 (for simplicity’s sake), your company would contribute $9,000 per year. Let’s see how that looks:
That’s over $3M by age 60 (and you started when you were 35). It’s never too late (or early) to start!