You're trying to save for retirement and you've heard that the 401(k) plan is a good way to start. But what about your regular savings? Maybe you think your regular savings account does the same job. A savings account can help you save for retirement, but it doesn't offer tax-deferred interest like 401(k).
Let's compare 401(k) and a regular savings account. If you earn $15,000 a year and save $1,000 for your retirement in a regular savings account, you pay taxes today on the full $15,000 of income.
If you save $1,000 under the 401(k) plan, that $1,000 is subtracted from your total pay before you figure your taxes. See the chart below.
401K plan vs Regular Saving Account
| |
401K Plan |
Regular Saving Account |
| Total Pay |
$15,000 |
$15,000 |
| Savings |
$1,000 |
$1,000 |
| Taxable Pay |
$14,000 |
$15,000 |
| Tax Savings(15% Bracket) |
$150 |
$0 |
That increases your cash flow by $150 and you still have $1,000 in savings. The more you save through 401(k), the less current taxes you pay. And the more you save, the faster your tax-deferred interest grows too. The chart below tells you what the tax savings might be with a 401(k) plan.
| Annual Savings |
15% Tax Rate |
28% Tax Rate |
33% Tax Rate |
| $1,000 |
$150 |
$280 |
$330 |
| $2,000 |
$300 |
$560 |
$660 |
| $3,000 |
$450 |
$840 |
$990 |
| $4,000 |
$600 |
$1,120 |
$1,320 |
| $5,000 |
$750 |
$1,400 |
$1,650 |
401(k) plans remain one of the most popular ways to save for retirement. That's because a 401(k) can reduce current taxes, allow tax-deferred savings, and increase today's spendable income.
But a 401(k) plan can't entirely replace a regular savings account. Deposits you make to a 401(k) work best when they stay under the plan until you retire.
Depending on your plan's provisions, your funds may be available to you before retirement under certain circumstances. You pay regular income tax on any withdrawals before retirement. Other penalty taxes may also apply.
With 401(k) you can save for your future, defer taxes, and reduce your current income taxes. 401(k) —let it work today for your tomorrow
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