At some point, you will need to leave the workforce, whether you want to or not. You may think that social security will help you get by in these golden years, but with the average social security payment hovering around $1,827 a month (you read that right) you’d better hope that your home is paid off, you never get sick, and that you never need to travel.

Life doesn’t sound so good when it has so many limits. If you want to have money to spend when you can no longer make money, you’ll need to start saving. If you plan ahead, you’ll be able to travel, give gifts, live where you want, and pay for the treatments and medicine you’ll need without worrying. And you will need them: as Americans live longer lives, their medical costs increase in retirement.

Saving does not mean hiding your money under a mattress, or even in a savings account. In fact, because of inflation—not just the rampant inflation we’re experiencing today, but even gradual, ever-present inflation—your cash is losing its purchasing power.

You’ve got to find a way to grow your money, not shrink it. And for most employed Americans, that means saving regularly in a 401(k).

A 401(k) is an employer-sponsored retirement plan. That means your employer will set up a retirement account for you, and you can make periodic contributions to that plan, often by contributing a portion of every paycheck. Although it’s not required, around 98% of employers who offer 401(k) plans will match your contribution (more on that later).

There are other types of employer-sponsored retirement plans. If you work in the public education system, or certain types of 501(c)(3) tax-exempt nonprofits, your retirement plan will be called a 403(b). A 403(b) may have lower management fees, and employee matching is less common. But other than that, there is not much of a practical difference other than the fact that 401(k) is for the private sector, and 403(b) is for the public sector. There is also the 457 Plan for government employees.

Some companies may also offer something called a pension plan. Employers often fund pensions, but if you leave that company, you can’t take the pension with you (to clarify, the money doesn’t disappear, but you cannot move it to, for example, a 401(k) at a new company). When you hit retirement age, the pension will begin to pay out. The Pension Benefit Guaranty Corporation is a government body (like the FDIC) that will ensure you get paid if the company goes bankrupt. One downside of pensions is that the contributions are often based on seniority and tenure. A 401(k) is different in that you can control how much goes in…up to the annual limits.

Some companies also might offer an employee stock sharing plan (ESOP), which is not a 401(k). This type of plan gives employees shares of company stock. If your employer does this, that can be a great opportunity to build wealth, especially if the corporation is promising. But it’s also like putting all your eggs in one basket; you know what they say about that. For this reason, you should still take advantage of a 401(k) if they offer it.

In any case, the main purpose of a 401(k) is to save for the future.

You especially need a 401(k) if you’re 20 years old. That’s because the 401(k) grows through compound interest, and the power of compound interest increases the longer it has to work. Say for example, that you did not decide to start a 401(k) until you were 40 years old, and you make an average annual contribution of around $7,000. Let’s also assume that your 401(k) grows at a reasonable rate of 8% every year and that you’ll work for the next 30 years, making the same contributions annually. By the time you retire, you’ll have around $856,422 saved, which is not a bad chunk of change.

But look how much you might have missed out on if you had started a 401(k) at the age of 25. For simplicity, we’ll assume that back then you could have also socked away $7,000 each year. Now you’re looking at 45 years of growth, or 50% more time for compound interest to work its magic. But wait…it gets better. By the time you retire, you wouldn’t just have 50% more money. You’d have $2,921,982, or 241% more.

Another way of looking at it is that by starting a 401(k) at the beginning of your professional life, you’d save and grow an additional $2 million. Of course, the exact numbers will vary with your income and other factors, but the point remains the same.

Maximizing the power of a 401(k) means you need to start contributing to one in your 20s. Another reason you want to get started earlier is because it might mean an earlier retirement. Going back to our previous example, if you didn’t start your 401(k) until you turned 40, you pretty much need to work for the next 30 years even to get close to a million dollars. By contrast, if you started saving in your twenties, you could hit two million after 40 years of work and retire 5-10 years earlier.

As a side note, in order to maximize your social security payments, you should not start collecting those until you turn 70. Although, as it turns out, this is yet another reason to start saving early—if you retire from working before you collect social security, you’ll need some money to bridge that gap. This kind of long-term planning that facilitates an earlier retirement is just one of the many steps you can take toward financial independence.

Your employer may present options for different types of 401(k) you can invest in, although some employers only offer one. The average number is 8-12, which seems overwhelming. But considering your age, goals, and other potential retirement assets can be part of the decision.

Some investment options will focus on stocks, while others will focus on government bonds. Others might focus on annuities or insurance products, while others represent a diversified basket of securities, cash, and maybe even gold. And still, others might be specifically designed to grow with you, such as a target-date fund or lifepath fund.

Your employer should provide you with some written information about each 401(k), and may have a point person in HR you can discuss your investments with. If they don’t, the financial institution they use to service the 401(k)s may have a number you can call to speak with a financial advisor.

Your 401(k) will have a money manager who makes investment decisions behind the scenes. This is different from a brokerage account, where the account holder can choose what types of stocks, bonds, securities, and derivatives (like options) are purchased to grow the account. Your portfolio manager will also occasionally balance your portfolio, which means adjusting the makeup of its components through buying and selling stocks, bonds, and other assets.

In broad strokes, some general strategies are used. Early in the lifespan of the 401(k), the money manager may have it invested mostly in stocks. Stocks are more volatile than other types of assets, but they have the greatest growth potential. The ups and downs of the stock market are okay at this point because the employee (you) has several decades ahead of them, over the course of which the ups and downs will balance out for overall growth—which might average 8%.

As the 401(k) moves closer to the date the employee would retire, the money manager may begin shifting its contents towards more stable assets, like bonds. The downside of these assets is that they have very minimal growth. The upside of these assets is their stability. Since the portfolio has already been growing over the years, and since stocks can go up and down, it’s better to shift the money into positions where it will hold its value. As the employee enters retirement, they will be drawing from the 401(k) to supplement their lifestyle, so volatile investments (like stocks) are no longer the best choice.

This retirement plan type is often called a lifepath or target-date fund. Other plans may only focus on one type of security, stocks or bonds, regardless of where you are in life. But in any case, those details behind the scenes are beyond your control.

What you can do to grow your 401(k) is make regular, consistent, and committed contributions. The easiest way to do this is to have a portion of your paycheck automatically allocated to the retirement account, optimally 10%. But even 5% or less is something that will grow over time. Remember that the more you contribute, the more money you’ll have later. At the very least, you should contribute as much as your employer will match you (more on that later). And if you think you can’t afford to allocate a portion of your paycheck to your 401(k), you probably can. You might just need to save money in some other areas.

You must avoid touching the funds in your 401(k) for a few reasons. One is that these funds are meant for your retirement, when you cannot work and generate income. It is also a time when you need the money for medical expenses, which seem distant but outweigh discretionary spending in the present. If you want to tap into your 401(k) for a large expense like a home remodel or addition, better options like a HELOC loan allow you to turn your home equity into a credit line.

Another reason you want to avoid taking money out of your 401(k) is that there will be tax repercussions. If you withdraw funds from a 401(k) before the age of 59 and a half, you’ll need to pay income tax on that money, plus a 10% fine. Imagine taking $30,000 from your 401(k) to pay for a wedding. Income tax varies from person to person, but even in the lowest tax bracket of 10%, that will still cost you $3,000, plus another $3,000 fine.

Keep in mind there are exceptions to this rule. If you become permanently disabled, you can withdraw the money without penalty. The same is true if you need the money to pay for other medical expenses, health insurance premiums, to pay back the IRS, or because you’ve been called into active military duty and need that money to support your dependents.

In addition to these hardship exceptions, other scenarios allow for penalty-free withdrawals. First-time homebuyers can take out up to $10,000 without incurring the 10% penalty. They could use this money as a down payment and to cover closing costs. However, per the first point, they should consider that this money will no longer be in their 401(k) accruing interest. There might be alternative solutions, like an FHA loan with a lower down payment.

Penalties, taxes, and exceptions aside, you don’t want to take money out of a retirement account because you want it to grow. If you have no other way of getting the money you need, you should talk to the financial institution that manages your 401(k) about taking out a loan against the cash value of your account.

Think of your 401(k) as a nest egg for the future. You don’t want to crack it open until you need that omelet. The discipline to avoid cracking this egg is just one of the many habits that can help you actualize financial success.

The difference between a traditional 401(k) and a Roth 401(k) is due to their tax implications. In a traditional IRA, your contributions are considered pre-tax, so you will need to eventually pay taxes on them when you take the money out of the 401(k). With a Roth 401(k), your contributions are considered post-tax. Since you’ve already paid taxes on them, you won’t need to pay taxes on them later.

Either way, you are required to start withdrawing from a 401(k) at 72.5 years of age. Also, note that while a Roth IRA (independently managed retirement account) has income limits preventing some people from opening them, a Roth 401(k) does not.

The main difference is that a traditional 401(k) growth is tax-deferred, while growth in a Roth 401(k) is tax-free. Which one you choose mainly depends on your financial situation, and whether it would be better for you to pay more taxes now or later. That’s the type of question you must ask a financial advisor.

The maximum amount of money an employee could allocate to their 401(k) in 2023 is $22,500. This amount has grown over the years, and will likely continue to grow in increments of $500, based on inflation (for example, it jumpbed $2,000 from the previous year). Employees who will turn 50 in a given year are allowed to make catch-up contributions of an additional $7,500, which will also increase in increments of $500, based on inflation.

There are also limits on how much an employer can contribute. They can match your contributions 100%, or the total contribution from both employee and employer can go up to $66,000, whichever number is lower. For most working individuals, these contribution limits translate to a monthly contribution well beyond the generous recommended 10%.

Your company may match your contributions. The most common match is 50% of your contribution, but no more than 3% of your salary. Sometimes an employer match will grow based on your tenure. For example, when you first start working somewhere, they may match up to 1% of your paycheck, but add a percentage for every five years you work there.

Let’s take an example. Suppose your biweekly paycheck is $6,000 and your employer has the abovementioned policy. If you allocate $600 of that paycheck to your plan, they will contribute 50%, or $300. If you contribute only $300 (5%), they’ll contribute $150.

Company matching can accelerate the growth of your 401(k) because of compound interest. The more money you have growing, the more it can grow, because the interest you earn also starts growing. That said, it’s important to max out the employer match the guideline for your minimum contribution amount.

If your company does not offer a 401(k), you will need to make one on your own. It won’t be called a 401(k), but an IRA, or independent retirement account. Just like the 401(k), it can be a Roth or Traditional IRA, each with its own tax implications (discussed above).

You can contribute to your IRA manually at your discretion by transferring money from your checking account. But most financial institutions will allow you to set up automatic transfers. And some of them can also work with your employer’s payroll department to automatically deduct a portion from your paycheck to be sent to the IRA.

Whatever you choose to do, you’ll have to stay as disciplined as you would with contributions to a 401(k). If your employer cannot work with the bank to facilitate payroll deductions, you should set up automatic contributions so you make sure to pay yourself first (or rather, your future self). You won’t be able to take advantage of employee matching, but some banks do match. For example, Robinhood matches contributions up to 1%.

Contributing to a 401(k) already requires some motivation to allocate a portion of your paycheck. If you’re self-employed—with no HR department managing your payroll—you might need some self-motivation about saving for the future.

One rule is that you must wait until 59.5 years of age to start making withdrawals, with specific hardship exceptions or the first-time homebuyer rule. In the case of a traditional 401(k), you must start taking withdrawals at age 72.5. Either way, the amount of money you must withdraw is based on a formula made by the IRS, which factors in your age.

For example, according to the Required Minimum Distribution Table, someone who has turned 74 has a “distribution period” of 23.8. Whatever their 401(k) balance is, they must divide that number by 23.8 to determine how much they’re required to withdraw for that year. If, for instance, their balance is $2 million, they must withdraw $84,033 for that year. If you’re wondering, this table applies to both IRAs and 401(k)s.

A Roth 401(k) is subjected to the same rules, but you can roll a Roth 401(k) into a Roth IRA, which is not subject to minimum distributions. This loophole is partly because you’ve already paid taxes on this money. By contrast, traditional 401(k) owners did not yet pay taxes. Since Uncle Sam wants his share of that money, he has mandated minimum distributions or RMD.

If you’re reading this article, you work for a company that offers these plans and don’t have a 401(k), you need to get one NOW! One of the first things you should do this week is contacting your HR department and set one up, contributing the maximum amount you can to take advantage of employer matching. If you can afford to allocate more, you should do so, because you might have some catching up to do. In the future when you can comfortably pay for necessary expenses—like medical bills—and discretionary purchases—like travel—you’ll be happy you contributed to that 401(k).

Do you think it would be hard to allocate 10% of your paycheck toward retirement? What kind of financial sacrifices would you make in the present to build a nest egg for the future? How would you help yourself to stay motivated and on track? Comment Below!