In the personal finance realm, the first order of business is to pay yourself. This is a very simplistic concept overlooked by so many. We constantly strive to make extra money by taking on a second job, or selling off items we own, and we often forget about the easier and more conventional ways to make extra money. A 401K is a great investment and money saving vehicle that can guide you along to retirement. With the fate of social security up in the air, itâ€™s time that we focus on alternative means of preparing for retirement.
As of 2012, you can now contribute a maximum of $17,000 to your 401K, as opposed to $16,500 from last year. By law, the maximum contribution rises in accordance with inflation each year. Those 50 and older can contribute an additional $5,500 to their plan. These are all pre-tax contributions, and depending on your employer match they can equate to tens of thousands of dollars invested each year. The best part is that you are funding the account with tax free dollars. Granted you pay tax at the time you withdraw the funds in retirement, but chances are you will be in a lower tax bracket and in the meantime you earn interest on a higher principal amount. Bottom line is that if your employer matches your contributions in any way, that is the very minimum you should be investing from each pay cycleâ€¦otherwise you are truly throwing away free money.
Some other interesting aspects to note are the penalties for early withdrawl. Not only will you get hit with one large tax bill, but you will have to pay an early withdrawl penalty as well. That penalty could literally wipeout all of our investment gains in one swoop. Just to note, early withdrawl means any age prior to 59 1/2. There are a few exceptions to the early withdrawl clause, such as medical bills, down payment on a home, or in the event of your own death.
Just to illustrate the importance of a 401k one last time, I will note that they have only been around since 1981 yet they are the most widely held retirement account in the United States!