Putting away a bit of money is easy. Waiting -- through market crashes, recessions, and your 50s -- is the hardest part.
In theory, saving is easy. You just keep some of your money instead of spending it. But being a savvy saver -- maximizing the amount of money you have in the future through your savings -- is far more difficult. These days there are all sorts of options out there for savings plans, and different actions you can take within those options. Navigating through it all is pretty tough without professional guidance. Instead, some people just plow a portion of their paycheck into a 401(k) savings plan each month. If this describes your investment philosophy, here are five tips to help you get the most value for each dollar you save.
Tip #1: Enjoy Pre-Tax Savings
Saving through a 401(k) plan will allow you to save money without feeling like you're saving as much as you actually are. For example, a person who earns $50,000 per year could save $325 pre-federal tax and $250 post-federal tax to earn about the same net monthly pay. That's 30% more savings due to deferring taxes.
Earlier this week, an article at MarketWatch argued that some people might want to save post-tax instead. The idea is that, since taxes will likely rise in the future, it would be better to incur taxes now on savings and pay lower rates later. This advice would apply if the tax rate rises by a pretty big margin. In the example above, effective tax rates would have to increase by about 7%, which would be a pretty big increase for the lower tax brackets many Americans will likely find themselves in during retirement, compared to when they're working.
Federal income taxes for retirees are likely to be low in part because Social Security is taxed at a lower rate than other income. In some cases, it isn't taxed at all, and at most up to 85% of your Social Security payments are taxable.
The exception to this rule, however, would be for Americans with very high incomes who have saved enough to sustain a very high income during retirement. Tax rates are likely to grow significantly for upper-income Americans over the next decade.
Tip #2: Whatever You Do, Go for the Match
If you do one thing to manage your 401(k), make sure it's to take full advantage of any match that your company might offer. For example, some companies will match employee contributions to their 401(k) up to some percentage, like if you contribute 6%, they'll provide another 4%. Make sure you save at least enough to get the maximum benefit. If you don't, it's like denying yourself a part of the salary that your employer is willing to pay you. For more information see this post.
The opportunity to match provides another reason that it's important to save pre-tax. Some companies that have matching programs will not offer a match unless you contribute to your 401(k) in pre-tax contributions. Without that match, you can often deprive yourself of a huge portion of potential savings. That additional amount of savings is likely amount to more than any benefit you get by trying take advantage of today's low tax rates, even in the most pessimistic of likely tax rate hike scenarios.
Tip #3: Ignore Market Shocks
When the economy was falling apart back in late 2008, it was very tempting to sell all of your 401(k) stock and transfer the money into safer assets. For example, let's say you got nervous in November when the S&P 500 index plummeted to 800 -- a 44% drop from a year earlier -- and sold all your index funds. You probably didn't feel safe putting your money back in the market with the unemployment rate in double digits throughout 2009, so you waited until the beginning of 2010, when the S&P was back to around 1,150. Your panic would have cost you dearly. If you took out $100,000 in 2008, you would have been $43,750 richer if you left your money in the market.