One Easy Way to Increase Your Net Worth Fast

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I am the first to admit that I am not naturally good at managing my money, and it’s something that I consistently need to be conscious of and work at. I don’t know about you, but I’ve always felt underprepared in that area. They don’t teach personal finance in school and I also am the type of person that tends to focus on the present and what’s in front of me right now. So it goes against my nature to look into the future and plan for stuff like “retirement.” For me, it’s hard to think of what I’ll be doing next year, let alone in 30 years from now!

But I’ve learned that this line of thinking is not optimal when it comes to saving. And, saving money is the best way to achieve financial security.

For me, saving is really hard because I gain a lot of happiness out of buying stuff.  I look at it as a form of personal expression. In my mind, I’m like, why would I work if I can’t spend?

I share this because I think that it’s hard for a lot of people to save. Expenses add up, depending where you live, the cost of living could be really high, you may have medical expenses on top of that, and it’s easy to fall into the trap of having a lifestyle that you can barely afford (maybe your rent is high or you have a high car payment, etc).

So what I want to share is some knowledge that finally convinced me to start saving for the future and making it a priority. And that knowledge revolves around 401K contributions.

I am personally convinced that 401K’s (or alternative plan) are the best way that an average person can build up their net worth and save for the future.

Contributing to Your 401K is the Fastest and Most Efficient Way to Build Your Net Worth

In my early days when I first started my career, people would tell me to contribute to my 401k using phrases like “company match” and “free money” and it would usually go in one ear and out the other.

Then one day I was having a conversation with M@ and he whipped out a calculator and started showing me how much money I could have in as little as 3 years and then 5 years if I started contributing certain amounts to my 401K. My mind was blown. Nobody had ever actually shown me how much I could have if I started saving. And that is what served as the catalyst that made me start valuing saving in my 401K.

So, in an effort to give you guys a similar experience of “show and tell” I’m going to run through a few scenarios to show you how powerful a 401K can be:

Scenario 1:

  • Salary: $50,000
  • Company Match: 3% of your salary

Let’s say your salary is $50,000 and your company offers a match of 3% of your salary (this is about the average—you should check your company’s policy for an exact amount!)

If you set up a contribution of 10% of your salary, that would be $5,000 a year.

Add the $1,500 from the 3% company match and you have $6,500 a year going into a 401K.

  • In three years, not accounting for any returns you earned, you will have $19,500.
  • In five years, assuming your contribution has stayed the same and not accounting for interest you would have $32,500.
  • In 10 years, you’d have $65,000 stashed away in your 401K, excluding any returns.

And this is all assuming your salary stays stagnant and you don’t increase your contributions.

Not bad…

And these calculations are just the bare minimum because it’s assuming your contribution wouldn’t increase (though hopefully it would!) and doesn’t account for interest earned.

Building wealth is a game, and if you want to play the game, you’ve gotta know some rules!
— With Some Flourish

Now there is something else we need to consider: the tax savings!  I know that the mention of the “t” word automatically triggers the word “BORING” in your head (it does in mine!) but hear me out because taxes matter and they really add up. Let’s say your average tax rate is 18%.  That means for every dollar you earn, on average, 18 cents, goes to the government.  But with a 401(k), the money you put in, is not subject to tax right away.  So, turning back to our example:

  • You contribute $5,000, without paying taxes on it right now, which means you “saved” $900 (18% of $5000) in taxes that you would have had to pay to the IRS that year.
  • But there is more, the match of $1,500 from the company also goes in without taxes.  Normally any money a company gives you is subject to taxes, but not 401(k) money.  So you saved an additional $270 in taxes (18% of $1500). 

So let’s review:

1)     Your savings went up by $5000

2)     Your tax bill goes down by $900

3)     Your company gives you an additional $1500 for free without you being taxed on it right now

Scenario 2:

Now, let’s say you get to a point where you can max out your 401K (I’d say once you start earning a “high” salary which could be anywhere from $60-150K depending where you live and your individual expenses). Side note: one way to start increasing your 401K contributions is this: Any time you get a raise, pour that raise directly into your 401K contribution. And then, once your 401 is maxed out, you don’t have to think about it anymore!

When you “max” out your 401K that means you’re contributing the highest amount allowed. Currently, it’s $18,000 a year, but here's some news, it’s going to be $18,500 in 2018.

So, let’s say you are at a point in your salary life where you can pack $18,000 (or as close as you can get to that) per year away. Remember, 401K contributions are taken out before your money is taxed, so they’re also a super-efficient way to save money as well because it maximizes the amount of money that stays in your pocket and out of the government’s pocket! (At least for now until you start withdrawing the money).

Let’s say you make $90,000 so the 3% company match would be $2,700.  So contributing the maximum of $18,000 for 2017:

  • In three years, you would have $62,100, not accounting for any returns earned.
  • In five years, you would have $103,500, not account for any returns earned.
  • In 10 years, you would have $207,000, not accounting for any returns earned.

Remember; let’s also consider the tax savings.  Now that you are making a higher salary, your average tax rate is going to go up.  So let’s say you have an average tax rate of 25%.  So your tax savings would be as follows:

  • In 1 year you saved $4,500 (25% of 18,000).  That means you would have had to pay $4,500 more that year to the IRS if you didn’t save the maximum.
  • In 3 years, assuming nothing changes, you would have saved $13,500 in taxes.
  • In 10 years, assuming nothing changes, you would have saved $45,000 in taxes.

One way to look at the tax savings is that the government is helping you save more for the future.  Think about it.  If you save the maximum of $18,000 for the year but that reduced your tax bill by $4,500, it’s kinda like the U.S. Government GAVE you $4,500 towards the $18,000.  So it’s like you agreed to save $13,500 and the government decided to throw in $4,500.  That doesn’t even include what your company does. 

I don’t know about you, but I think that’s a pretty good chunk of change on both the savings and tax fronts! :)

I ran through these scenarios above because I think it’s impactful to see real numbers on paper of what could be possible if you start saving in your 401k or alternative plan.

One last thing, people who are very financially savvy will say “Okay Elyse, but the government is going to tax us on this money in the future, so it’s not really tax-free!”  My response is this: 401K's are a powerful way for a normal person to save money right now and avoid paying taxes for up to 40 years on any of their investment returns.  Unless you’re already a start-up baller, this is the way to go as part of a complete financial plan.  

What do you guys think? What are some ways that you save money?