8. Max Out Your 401(k) Contributions
Recommendation
A 401(k) is a retirement savings plan sponsored by your employer, allowing you to contribute pre-tax dollars, which grow tax-deferred until withdrawal in retirement.
Earlier in Step 2, we recommended you contribute to the 401k upto the employer match. Now it's time to max out contribution to maximize the tax deduction advantage.
Why Maxing Out Your 401(k)
- Tax Advantages: Contributions reduce your taxable income, lowering your current tax bill. Earnings grow tax-deferred.
- Employer Match: Many employers match contributions up to a certain percentage, effectively providing free money.
- High Contribution Limits: For 2025, the contribution limit is $23,500, with an additional $7,500 catch-up contribution for those aged 50 and older.
- Compound Growth: The earlier and more you contribute, the more your investments can grow over time due to compounding.
Example
Assume:
- You contribute the maximum $23,500 annually to your 401(k).
- Your employer matches 50% of your contributions up to 6% of your salary.
- Your investments grow at an average annual return of 7%.
After 30 years, your account balance would be approximately $3.5 million, including employer contributions and compound growth.
Steps to Max Out Your 401(k)
- Automate Contributions: Set up automatic payroll deductions to ensure consistent contributions.
- Increase Contributions Gradually: If maxing out immediately is challenging, increase your contribution rate annually.
- Take Advantage of Catch-Up Contributions: If you’re 50 or older, contribute the additional $7,500 allowed.