Millennial and Gen Z employees know the value of an employer-sponsored retirement plan. A recent survey by Betterment found that 79% of Millennials and 84% of Gen Z would leave their current job for one with better financial benefits. But when it comes to contributing, the numbers go down a lot. A Bank of America study found that only about 55% of Gen Z and Millennial employees contribute, and 70% of Millennials contribute less than $5,000 annually.
The Importance of Starting Young
Contributing to a retirement plan means reducing your available income. It also reduces the amount you pay in taxes, but when you’re at the start of your career, the tax benefit may not seem like it outweighs the loss of funds every month.
Early career also means high expenses, a high debt load, and lower total income to meet those expenses. It can be very tempting to kick the retirement can down the road and let 40-year-old you, with your student loans paid off and a bigger salary, handle the retirement savings load.
However, expenses tend to expand to the level of your income, so saving never really gets easier. But more importantly, saving even small amounts and investing over a longer period harnesses the power of compounding.
Let’s assume you start at age 42 and save $500 per month. Assuming an 8% annual return, by age 65, you’ll have accumulated $395,866, not accounting for taxes or inflation.
If you start at age 22 and save only $100 per month, under the same assumptions, you’ll have $451,169 at age 65.
The value of saving early isn’t just that you have a longer time to accumulate savings for retirement. You are also amassing savings that you can borrow from.
Borrowing From Your 401(k)
Your plan sponsor determines the rules for 401(k) loans, but you may be able to take out as much as 50% of the total value of the account. Loan amounts are not taxable, and you won’t incur a penalty on the funds. However, the loans are not open-ended; you generally have to pay them back, with interest, within 5 years of taking out the loan. If you default, you’ll have to pay taxes and penalties – but the default won’t impact your credit score.
The good news is that the interest you pay goes back into your account, along with the principal. So while you are removing money from the investments you’ve decided on in your plan, and you will forgo any growth on the funds, you will get some benefit.
Retiring at 55 and Rule of 55 for 401 (k)
Since you’ve started amassing retirement savings early, you may have the option to retire early and not wait until you’re in your 60s. However, 401(k) withdrawals before age 59 ½ usually incur a 10% penalty.
Per the IRS, the Rule of 55 enables workers who leave their job for any reason to start taking penalty-free distributions from their current employer’s retirement plan once they have reached age 55. The plan works well for workers who want to retire early and those who require cash and thus tap distributions from their retirement plans sooner than is typically permitted. However, not all plan sponsors offer this option.
Normally, distributions from tax-qualified retirement plans, including 401(k) plans, before age 59 are subject to a 10% early withdrawal tax penalty. However, the Rule of 55 may enable an employee to obtain a distribution at age 55 and not be subject to the penalty for early withdrawals. A distribution would still be subject to an income tax withholding rate of 20%. However, if you owe less than you earmarked for the annual 1040 form, you will receive a refund after filing annual returns.
Another important consideration, the employee’s funds must be kept in the employer’s plan before withdrawing them, and the employee can only withdraw from the current employer’s plan. If the employee rolls over the funds to an IRA, the Rule of 55 tax protection is lost.
Saving early and often in a 401(k) isn’t just to ensure a good retirement 40 years down the road. You’re creating a source of funds you can borrow from and giving future you the option to retire much earlier.
To schedule a call to review your financial plan and investments Click Here
SUBSCRIBE TO THE FINANCIAL INCLINE
This work is powered by Advisor I/O under the Terms of Service and may be a derivative of the original.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
This content not reviewed by FINRA
Incline Wealth Advisors, LLC, its owners, officers, directors, employees, subsidiaries, service providers, content providers and third-party affiliates (referred to as “IWA”) do not offer the sale of securities or other investments. None of the information provided is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. The content is provided ‘as is’ and without warranties, either expressed or implied. IWA does not promise or guarantee any income or particular result from your use of the information contained herein. Under no circumstances will Incline Wealth Advisors, LLC be liable for any loss or damage caused by your reliance on the information contained herein. It is your responsibility to evaluate any information, opinion, or other content contained. Please seek the advice of professionals regarding the evaluation of any specific content. Information on this website should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized. The information on this site is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Incline Wealth Advisors, LLC(referred to as “IWA”) disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose. IWA does not warrant that the information will be free from error. None of the information provided on this website is intended as investment, tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall IWA be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the materials in this site, even if IWA or a IWA authorized representative has been advised of the possibility of such damages. In no event shall Incline Wealth Advisors, LLC have any liability to you for damages, losses, and causes of action for accessing this site.