Money Girl explains 7 major pros and cons of having a 401k through your job, and gives you tips on how to save quickly - so you have plenty of security when you’re ready to kick back and enjoy retirement.
A 401k retirement plan is one of the most powerful savings vehicles on the planet. If you’re fortunate enough to work for a company that offers one, it’s an incredibly valuable benefit that you should take advantage of.
But many people ignore their 401k plan at work because they don’t understand how it works, worry about what will happen if they leave the company, or mistakenly believe you must be an investing expert to use it.
In this episode, I’ll explain 7 major pros and cons of using a 401k. You’ll learn some of the lesser-known benefits of the program, and get tips on how to save money quickly - so you'll plenty of security when you’re ready to kick back and enjoy retirement.
What Is a 401k Retirement Plan?
A 401k is a type of retirement plan offered by employers, and is also available if you’re self-employed. It allows you to contribute a portion of your paycheck, before taxes are taken out, to a variety of investment options such as stock funds, bond funds, and money market funds.
Because you put money from your paycheck into a 401k on a pre-tax basis, making contributions reduces your annual taxable income and the amount of tax you have to pay. You defer paying income tax on contributions and growth in the account until you take withdrawals in the future.
However, there’s another option that’s becoming popular called a Roth 401k. With a Roth, you pay tax on your contributions upfront—but typically don’t have to pay any tax on future withdrawals of contributions or investment earnings.
This is similar to the way taxes work with a Roth IRA; however, a Roth 401k has a major advantage, because there’s no income limit. You see, high earners are disqualified from contributing to a Roth IRA—but that’s never the case with a Roth 401k.
How Many Americans Have a 401k Retirement Plan?
According to the Investment Company Institute (ICI), about 52 million workers in the United States participated in a 401k retirement plan in 2012. These accounts hold an estimated $4.4 trillion in assets, which has doubled since 2004.
The ICI’s research showed that 401k balances increase with a participant’s age and the length of time they’ve worked for their employer. For instance, workers in their 60s with 30 years of tenure had a balance of $224,287 at the end of 2012, while workers in their 40s with more than 5 to 10 years of tenure had a balance of $53,060. The average account balance across all age groups was $63,929.
Pros of Investing in a 401k Retirement Plan at Work
When I started my career over a decade ago and heard about my company’s 401k plan for the very first time, I didn’t enroll in it. I was nervous about having investments with an employer, because I didn’t understand what might happen to my money if I left the job, or if the company went out of business.
I want to put your mind at ease about using a 401k, because there are many more advantages than disadvantages to doing so. Here are 4 major pros to consider before investing in a retirement plan at work: