You get large tax advantages, the money is automatically taken from your paychecks before you have the chance to spend it, and sometimes your employer contributes money to your account in what's known as an employer match.
Perhaps most importantly, it allows you to compound money over time - and compound interest, if taken advantage of from a young age, can make you a millionaire.
Unfortunately, not all companies offer a 401(k) plan.
If that's the case for you, don't stress. You have options.
For one thing, you can always open a taxable investment account or high yield savings account to store money and mark these accounts for retirement. (If you're self-employed, you have other options in addition to those below.)
However, you may want to consider one of these three tax-advantaged accounts, designed specifically for retirement and accessible to employees without a 401(k) plan:
1. Fund a traditional IRA.
A traditional IRA (Individual Retirement Account) is just as it sounds: An account opened and maintained by an individual with the purpose of saving money for retirement.
Like a 401(k) plan, IRAs also offer tax breaks: You contribute pre-tax dollars and let that money grow tax-deferred over time. You'll pay taxes on your contributions (and investment gains) only when you withdraw the money, which you can do starting at age 59 1/2. Any withdrawal made before then is subject to taxes plus a 10% penalty fee.
The maximum yearly contribution is $5,500, or $6,500 for people age 50 or older.
2. Fund a Roth IRA.
With a Roth IRA, contributions are taxed when they're made, so you can withdraw the contributions and earnings tax-free once you reach age 59 1/2. This means you're only paying taxes on a portion of your savings (your contributions), while with a traditional IRA, you're taxed on every penny (contributions and earnings).
There's an income cap on the Roth IRA: Only married people earning less than $184,000, or single people earning less than $117,000, are allowed to make the maximum yearly contribution of $5,500 ($6,500 for people age 50 or older).
If you contribute to a traditional or Roth IRA, you'll want to check to see if you qualify for the saver's credit, a tax credit that could be worth as much as $2,000 for individuals and $4,000 for couples.
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Which one should you choose?
It depends on your individual situation. Do you think you're in a higher tax bracket now than you will be when you retire, or do you anticipate jumping a bracket or two by retirement age?
If you're earning more now, you might be better served with a traditional IRA, since you'll be paying taxes down the road; if you expect to earn more in the future, you might be better served with a Roth, since you pay taxes today.
Read more about the key differences between a traditional IRA and Roth IRA.
When you're ready to open an IRA, simply choose a firm and set up your account online. Try Fidelity, Vanguard, or TD Ameritrade. You can also walk into a brokerage firm, such as Charles Schwab or Merrill Lynch, or a bank if you want to set up your account with a real person.
3. Fund a myRA.
The US government recently launched a new type of retirement savings plan - myRA (My Retirement Account) - specifically designed for those who don't have access to a 401(k) or other retirement plan at work.
Like a Roth IRA, you contribute after-tax earnings that grow over time and can be withdrawn tax-free for retirement. You can also withdraw the money tax-free for emergencies at any time without penalty (unlike the traditional IRA and Roth IRA).
The income cap is $131,000 (or $193,000 if you're married and file taxes jointly) and employees can contribute up to $5,500 a year ($6,500 for people who are 50 or older).
The account has its pros - everyone within the income limit now has access to a no-fee retirement plan, and it encourages saving among a wider range of workers - and its limitations, most notably that the account is capped at $15,000. At that point, you have to roll the balance over into a regular, private IRA.
No matter the retirement savings account you choose, the most important step is to open an account. Next, take these three actionable steps so your money can grow and accumulate over time:
- Set aside as much of your pre-tax income as you can, preferably 10% or more.
- Make your contributions automatic, by either getting your employer to do a payroll deduction or having your money automatically moved from your checking account to your IRA. This way, you'll never even see the money and you'll learn to live without it.
- If you're making automatic contributions and haven't maxed out your IRA, get in the habit of upping your contribution on a consistent basis, either every six months, at the end of each year, or whenever you get a pay raise.
If you've maxed out your retirement savings account and still have money left over that you'd like to invest, research low-cost index funds, which Warren Buffett recommends, or look into the online-investment platforms known as robo-advisers.
Read up on the many different forms of investing before getting started.