We're told that we're supposed to sock away a portion of our paychecks rather than spend them in their entirety month after month, and thankfully, some folks out there are actually listening. In fact, last year, I reported that Americans are doing a better job of saving money -- though we still have work to do as a whole. But when it comes to housing our wealth, not all accounts are created equally. For example, there's a big difference between saving in a bank account versus a retirement account -- or just sticking a wad of money under the bed and calling it a day.
So where do most Americans put the bulk of their money? In a new GOBankingRates study, it turns out the answer is none other than 401(k)s. Specifically, 28% of U.S. adults stash the majority of their cash in 401(k)s, compared to 22% who keep most of their money in a checking account, and 18% who store their wealth in a savings account.
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Of course, having any sort of savings is far better than having none at all. But the fact that more people aren't stashing their wealth in a tax-advantaged retirement plan is troubling -- especially since an estimated 79% of workers today have access to a 401(k).
If you've been housing your savings in the bank, you should know that there are better options out there, be it a 401(k) or another retirement plan. Or, to put it another way, if you insist on keeping most of your money in the bank, you'll limit its long-term growth and risk coming up short in the future.
Why save in a 401(k)?
Employer-sponsored 401(k)s offer a host of tax benefits that regular savings and checking accounts do not. First, the money you contribute to a 401(k) goes in tax-free and gets to grow on a tax-deferred basis. It's only once you start taking withdrawals that taxes apply. The interest you accrue on a savings account, on the other hand, is taxed yearly as ordinary income.
Here's some more good news: The annual contribution limits for 401(k)s went up in 2018. Now, you can sock away up to $18,500 a year if you're under 50, or $24,500 a year if you're 50 or older. This means that if you're 45 and decide to max out, and your effective tax rate is 30%, you'll knock $5,550 off your IRS bill -- just like that.
But it's also the long-term growth opportunity that makes 401(k)s all the more valuable. Check out the following table, which shows how much wealth you stand to accumulate if you begin funding a 401(k) at various ages:
Remember, because 401(k)s don't make you pay taxes on your investment gains year after year, you get the option to reinvest those gains and use them to make even more money. In the above scenario, the totals outlined are based on an average yearly return of 7%, which might seem like an arbitrary number. But actually, that figure is based on the stock market's historical 9% average. Even though we've been in an up market these past number of years, we can't rule out the possibility of another downturn, and another one after that. That's why 7% is a reasonable estimate for someone whose 401(k) is highly invested in stocks.
Furthermore, you'll notice that the above table doesn't have us maxing out a 401(k) -- or getting anywhere close. What this means is that if you are able to contribute $18,500 or more annually for many years, and your investments do well, you could retire a millionaire many times over.
On the other hand, if you limit yourself to a savings account paying 1% interest or less, or a checking account paying no interest at all, your money won't see anywhere near that same sort of growth. The following table shows how well you'll do in a savings account scenario:
So there you have it. If you're among the 28% of Americans whose wealth is mostly housed in a 401(k), you're making a smart move for your future. And if your money is mostly in savings, pull out all but the sum you need for your emergency fund and stick it someplace tax-advantaged. If you don't have access to a 401(k), you can always save in an IRA. The key is to put your money someplace where you'll get the best of both worlds: tax savings and the opportunity for growth.
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