Extending Chapter 15: Retirement and Estate Planning

What You'll Do and Learn

• You'll learn how contributions to a company retirement plan can help reduce your taxes and build retirement savings.
• You'll calculate the after-tax cost of contributions to a company-sponsored retirement plan such as a 401(k).

Introduction

In this activity you will calculate the effect of making a regular contribution to a 401(k) plan on your take-home pay.

Chapter Notes

Chapter 15 explained the importance of planning ahead to ensure that you will have enough money to live on when you retire. By starting to save for retirement when you are younger, say in your twenties, rather than waiting until your are closer to retirement, you greatly increase the chances that you will have a sizeable retirement nest egg.

Some retirement plans allow the investor to defer paying taxes on investment earnings. These accounts include Individual Retirement Accounts and company-sponsored retirement accounts such as 401(k) and 403(b) plans. If your company offers such a plan, be sure to take advantage of this opportunity to build tax-deferred savings. Your investment balance can build much more quickly in a tax-deferred account compared to an equal investment in a taxable account.

Your contributions to a tax-deferred retirement account may also be deductible. Contributions to company-sponsored retirement plans are made in pre-tax dollars--you won't pay income taxes on your contributions or their investment earnings until you withdraw them. Your contributions are usually deducted from your paycheck. Because your contribution is made before taxes, your take-home pay is reduced by less than the amount of your contribution. The higher your tax bracket, the greater the tax savings.

Many companies will match all or a portion of your contribution to a 401(k) plan. In a typical arrangement, your company may add an additional dollar for every one you contribute, up to 3 percent of your wages, and 50 cents for every additional dollar you contribute up to 6 percent of your pay. So, if you contribute 6 percent of your pay, your company match would total 4.5 percent of your pay. That's equivalent to earning an immediate 75 percent return on your contribution!

Site Notes

Standard & Poor's 401(k) Contribution Calculator shows the effect of a contribution to a 401(k) plan on the contributor's take-home pay, after taxes.

Let Me Try

Go to the S&P Web site at and print the Worksheet activity.

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