How to More than Quadruple Your Investment, and Pay Less Tax

Hint: It involves your 401(k)

If you are at work right now, stop what you are doing, head to the payroll or HR department and grab the form to make changes to your 401(k) contribution (or 457 plan if government employee, or 403(b) if in the education field).

Fill out the form and increase your contribution by $20.00 per month. That’s $10.00 per check if paid twice per month or $5.00 if paid weekly.

If you are not at work, do it first thing when you next get back to your workplace. Set a reminder on your phone so that you don’t forget. Make it annoying and persistent; don’t let this opportunity go by un-seized.

If you feel me, have been meaning to do this anyway, or need no further persuasion to do as I suggest, then you are done. Move on to the next story or do whatever. No need to read more here, just make sure you follow through with the above.

If you need more reason than, “because I said so”, or are a bit confused because you don’t have any of those investment opportunities — or maybe don’t even know what they are — then keep reading. You will be on board soon.

First off, what is a 401(k) (or 403(b) or 457 plan)? These are all tax deferred investment vehicles that are offered to employees through different types of employers.

The 401(k) is the most common, and most likely this is a familiar term, even if you don’t know everything about them. A 403(b) plan is exactly the same, but it is typically available only for those working for public schools and certain non-profits. A 457 plan is also exactly the same, but typically offered to municipal, county and state government employees.

All three plans are tax-deferred (meaning you don’t pay any taxes until you withdraw funds) and use pre-tax income for funding. This means that you don’t pay any income tax up front on any funds you contribute to the account.

These types of tax-deferred investments are the ‘easy button’ for retirement savings and allow you to not only pay less taxes now but grow your money without tax for many years.

But what if you are self-employed or your employer does not offer such a plan?

The next best option in those cases are a traditional Individual Retirement Account (IRA). Traditional IRA’s are very similar to 401(k) (and the other) plans, except that you need to make the contributions yourself, and the contribution limits are lower than the other plans ($6,000.00 in 2020 compared to $19,500 for 401(k) and 457 plans).

Let’s look briefly at someone who is single, makes $30,000 annually and chooses to invest $20 per month in their 401(k) plan. Using 2020 tax brackets, and with everything else being the same, the person that contributes the $20/month ($240.00 for the year) will pay $28.80 less in tax than the person who does not.

They will also have $240.00 in their 401(k) account, plus interest. At the end of one year that may not be terribly impressive. With a very conservative interest return amount of 8%, our 401(k) contributor will have something in the ballpark of $259.20 in their account. This represents earnings of $19.20. Not earth shattering, but a good start.

But this is where compounding steps in. If they continue to contribute only that $20/month, at the end of 10 years they will have $3,515.00 in their account. $2,400.00 will have been the employee’s money and $1,115.00 will be earned interest. That represents a return of about 46%.

At the end of 20 years, still only putting in $20/month things get more noteworthy. The investor will have $11,065.00, of which $4,800.00 is their original money and $6,265.00 is interest. The return is now at 131%.

At thirty years the interest earned has climbed rapidly to $20,166.00 while contributions are only at $7,200.00. Return of 280%

And at 40 years (let’s assume our investor started at 20 and is now 60), the investment account stands at $62,559.00 with a whopping $52,959.00 of that being other peoples’ money. By investing simply $20 per month, our investor has more than quintupled his contributions of $9,600.00.

As promised, a way to more than quadruple an investment. Now you just need to take action.

Days have a way of turning into weeks, and weeks into months. With a 5 to 1 return ratio, each month you don’t put $20.00 into your retirement account is like giving away $100.00 of your retirement money.

Once again, your best routes for retirement savings are:

1. An employer sponsored tax-deferred plan such as a 401(k)

2. A traditional IRA, which is also tax deferred but with lower caps

3. A Roth IRA which uses after-tax income, but is not taxed at withdrawal

4. Any well-known after-tax traditional investment account

Allocate your funds by maxing out number 1 or 2 first (if you have a 401(k) you cannot also contribute to a traditional IRA).

Then max out your Roth IRA contribution (also capped at $6000.00 for 2020). Then start placing your retirement savings into a traditional after-tax investment account only when you have maxed out the two former options (1 or 2 plus 3).

If you aren’t maxed out, do not worry. You can see by the illustration how much earning potential just $20.00 per month has over time.

Today is the day. Walk into your employer’s HR department now and make the change. Then do it again next year — or the next time you get a raise. Then do it again every year until you max out.

If you don’t have an employer, or they don’t have a 401(k)-type plan, then open a traditional IRA account today. I use Vanguard because they have notoriously low fees, but there are countless options to use. Do you research, pick the firm you like the best and get started.

If you wait until next month to do it, you will have $100.00 less to spend in retirement. I guarantee it.

If you liked this story, you may also like:

Timothy Key spent over 26 years in the fire service as a firefighter/paramedic and various fire chief management roles. He firmly believes that bad managers destroy more than companies, and good managers create a passion that is contagious. Compassion, grace and gratitude drive the world; or at least they should. Follow me on Instagram, Facebook, and Twitter, and join the mail list.