The 3 Pillars for creating wealth:Pillar 1, Pillar 2, Pillar 3
Investment income is the second pillar for creating wealth (see Pillar 1).
Investment income is simply income that comes from interest payments, dividends, and capital gains collected upon the sale of securities or other assets.
Investment income through investing is one of the best ways to grow your wealth. That’s because of the power of compound interest. Warren Buffet is a huge fan of compound interest. He’s been preaching about compound interest for decades and it’s one of the reasons why he is a billionaire.
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” – Warren Buffett
There are many ways to invest. Although it helps if you can make good investment decisions, you don’t have to be Warren Buffett in order to be successful. All you really need to do is be consistent with your investing and let compound interest and time work for you. Investing in tax-advantaged retirement accounts such as a 401(k) or IRA can help you grow your wealth more quickly over time because you won’t have taxes dragging down your investment portfolio.
Investing in a 401(k)
As a quick refresher, a 401(k) is an employer-offered retirement plan that can offer you a substantial tax break on money you save for retirement. The best thing about investing in a 401(k) plan is that it is automatic, consistent, and the money is not easy to access. The money comes out of your pay automatically and does not get deposited into your checking or savings account where the funds can be withdrawn easily and used for frivolous purchases. Investing in a 401(k) is consistent because investing occurs each time you are paid your salary. This, in turn, makes it easier to save a money each month. Over time, what started off as a relatively small amount grows larger and larger as the power of time and compound interest work together to build your retirement account.
The Internal Revenue Service (IRS) imposes a limit on how much money annually you can contribute to your 401(k) account. This is called the 401(k) contribution limit. The good news is that the 401(k) contribution limit jumped up to $18,500 for 2018. Catch-up contributions for people 50 and older allow you to contribute $6,000 more into your 401(k); that is $24,500 in 2018.
Not only does the money you invest grow over time, but it also lowers your taxable income. For instance, if you make $100,000 each year and make the maximum contribution, which is $18,500, into your 401(k), you will only pay taxes on $81,500 of your income. In addition, the $18,500 you contributed will go into your savings untaxed.
Eligibility
According to benchmarking data published in 2014, 62% of employees can contribute to their company’s 401(k) plan with their first paycheck. It’s fewer for companies that provide matching contributions. About 46% of companies that offer the match give it to employees when they start work; another 29% require that the employee have one year of service before matching contributions begin.
Match Amounts
Your employer will generally match whatever you invest in your 401(k) account up to a certain percentage. The general contribution from an employer is usually between 3% to 6% of an employee’s pay. For employees to receive a contribution from their employer, the employee must contribute a specified percentage into a qualified 401(k) plan. The employer will then match the employee’s contribution to the retirement plan. Therefore, you should strive to invest an amount large enough to qualify for the employer match otherwise you are giving away free money.
Individual Retirement Account
An Individual Retirement Account (IRA) is a form of “individual retirement plan” provided by financial institutions that provide tax advantages for retirement savings.
An IRA, just like with a 401(k), allows income from interest, dividends, and capital gains to compound each year without taxes eating away it.
The benefits of an IRA account are not as robust as the 401(k) plan. The biggest disadvantage is that there is no employer match. Also, the government limits the amount of money you can put into an IRA each year. Most people under 50 can contribute no more than $5,500 a year; a limit that rises if you are older.
The good thing about having an IRA account, particularly if you have a 401(k) account and contribute up to the $18,500 limit, you can lower your taxable income by another $5,500 by contributing to an IRA.