What are the main benefits of investing in a 401k?
There are two basic advantages from a tax standpoint:
1). You end up paying less taxes now because the amount going to the 401k from your paycheck actually reduces your income for the year by that amount. Basically you will not be taxed on whatever amount you invest into your 401k. The total reduction of your taxable income by that amount might also put you into a lower tax bracket.
2). The big gain is that all of the money invested inside of the 401k grows tax deferred. Meaning the account is never taxed (until you withdraw the money). Another major benefit is that your compounding growth in this account will not be taxed until your start to withdraw the money. This will help you to increase your overall gains in the account.
Here’s an example:
If you invested $250 per month for 30 years in a regular taxable investment account, and you could average an 8% growth rate, you would have approximately $273,910 (based on estimated tax rates of 28% fed and 6% state)
If you invested the same $250 per month for 30 years in a 401k with an 8% growth rate (basically everything being the same other than the taxes), you would have approximately $372,589. This is almost a $100,000 difference. Over time, you can see how much the tax deferral adds up.
Another factor to consider is that most employers will match some of the money that you are investing into the 401k. You should consider this a free raise, and it will definitely increase your returns.
If you need some help in finding enough spare income to invest in your 401k, look into a credit counseling organization. For more information and new ideas on how to save money, check out the self-help resources at DebtGuru.com.
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