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S-t-r-e-t-c-h your 401(k) contribution

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It’s a great time to get your finances in shape. Have you considered “stretching” your 401(k) contribution?

You’ve already made a wise decision to participate in your
401(k) plan. You might be thinking that you are in good shape and have a long-term investing strategy in place. But here’s an important question: Are you contributing as much as you can?

Stuck in the default zone

After choosing to enroll, your contribution rate is your next most important decision. If your company offers an automatic enrollment feature, you may have been defaulted to a pre-set contribution rate. And you might be stuck at that default rate.

Even if you enrolled in the 401(k) plan on your own and chose your contribution rate, have you looked at it lately? It’s always a good idea to review your situation and see if you can bump up your contribution. Take a look at the illustration below that shows the potential assets of an employee making $40,000 annually and contributing 3% versus 6%.

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The hypothetical illustration above assumes a salary of $40,000 and contribution rates of 3% and 6%, with contributions made at the beginning of the month and 6% annual effective rate of return. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than their original cost. Taxes are due upon withdrawal. If you take a withdrawal prior to age 59 ½, you may also be subject to a 10% additional federal tax.

Meet your match

If your employer matches a portion of your contributions, as many do, it’s like getting “free” money so you should consider contributing at least enough to get the full match. If you can go above and beyond your employer’s match limit, more power to you!

Compounding is a beautiful thing

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Another way to see the potential impact of increasing your contributions is to understand the concept of compounding. What does it mean? Basically, compounding is when any earnings you make in your 401(k) account are automatically reinvested and can potentially generate more earnings over time—kind of like a snowball effect. By contributing as much as you can, automatically reinvesting any earnings, and avoiding taking loans from your vested balance, you can increase your chances of meeting your goals.

Consider this: Contributing just $100 per month ($1,200 per year) in your plan is just $3.33 per day. And if you increase your contribution to $200 per month ($2,400 per year), that’s less than $7 per day. Look at the example above. Hard to believe that contributing less than $7 a day—about the cost of buying a sandwich and chips at your local deli—could potentially result in an account worth more than $180,000! But that’s what bumping up your contribution rate and the power of compounding can do.

The hypothetical illustration above assumes contributions are made at the beginning of the month and a 6% annual effective rate of return. Hypothetical results are for illustrative purposes only and are not meant to represent the past or future performance of any specific investment vehicle. Investment return and principal value will fluctuate and when redeemed the investments may be worth more or less than their original cost. Taxes are due upon withdrawal. If you take a withdrawal prior to age 59 ½, you may also be subject to a 10% additional federal tax.

Juggling other priorities

Okay, so you understand how increasing your contributions can have an impact over time. You also get the concept of compounding. But you may be thinking, how can I find the money to increase my contribution rate when I have so many bills to pay today? Fair question. But small changes in your spending habits can make saving a little more for the future possible. Consider these ideas:

  • “Think b4 u app” – Think twice before you buy another app for that smart phone or download another song. Even though it may seem like a small amount each time, over the course of a year it can really add up. Do you really need all those apps? Think about channeling that money towards an increased 401(k) contribution instead.
  • Shop your closet – While it’s always fun to buy a new outfit, try shopping your closet rather than hitting the shops. By putting a few different pieces together, dusting off an old classic, or adding a scarf, you’ll have a brand “new” outfit, and money in the bank for retirement.
  • Spend smart – Some financial experts say you should consider skipping the take-out coffee and putting that money into your retirement plan. But some of us just can’t live without our morning java, and don’t have time to make it at home before work. Instead, look at some of the bigger ticket items. Do you really need that 52-inch television? Or that fancy tablet? Sometimes it’s hard to resist the lure of the latest gadgets. But instead of spending on the latest “must-haves,” increase your 401(k) contribution.

A few stray dollars here and there may not seem like much. But if you add them up week after week, month after month, you may be surprised at the total. And remember, by making contributions to your 401(k) plan on a pre-tax basis, you can actually increase your take-home pay. That’s because your contributions are made before federal (and, in some cases, state) income taxes are deducted. This could lower your taxable income.

Neither Merrill Lynch nor any of its affiliates or financial advisors provides legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

Learn more and take action

  • Ready to act now? If your company's 401(k) plan is through Merrill Lynch, you can increase your contribution rate at Benefits OnLine.
  • Watch this short video to see how starting early could impact your 401(k) account balance over time.
 
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