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 powerful, but lesser-known 401k benefit is protection from creditors.
401k Pro #1: Federal Legal Protection
Qualified workplace retirement plans are protected by a federal law called the Employee Retirement Income Security Act of 1974 (ERISA). It sets minimum standards for employers that choose to set up retirement plans, and for the administrators who manage them for you.
ERISA was enacted to protect your interests and those of your beneficiaries when you participate in a retirement plan at work. Here are some of the protections you get:
- Disclosure of important facts about your plan's features and funding
- A claims and appeals process to make sure you get your benefits
- Right to sue for benefits and breaches of fiduciary duty if the plan is mismanaged
- Payment of certain benefits if you lose your job or a plan is terminated
Additionally, a powerful, but lesser-known benefit is protection from creditors. Let’s say you have money in an ERISA-qualified account, but lose your job and can’t pay your car loan. If the car lender gets a judgment against you, they can attempt to collect debt from you in a variety of ways - but not by getting into your 401k.
So never be afraid that an employer could steal your money, or fail to release your funds, if you move on to another job. It’s easy to transfer funds into a 401k with a new employer, or open a rollover IRA that you manage on your own. However, note that there are exceptions when a qualified-ERISA plan is at risk, such as when you owe the IRS for federal tax debts, owe criminal penalties, or owe an ex-spouse under a Qualified Domestic Relations Order.
401k Pro #2: Matching Funds
Many employers that have a 401k retirement plan also offer matching contributions. These additional funds boost your account value. For instance, the company might match 100% of what you contribute, up to 3% of your income.
For instance, if you earn $50,000 per year and contribute 3%, or $1,500, your employer would also contribute $1,500 on your behalf. You’d have $3,000 in total contributions and have received a 100% return on your $1,500 investment. That’s not too shabby!
Free matching funds give you a raise for doing nothing. So always set your 401k contributions to maximize an employer’s match, otherwise you’re leaving easy money on the table.
401k Pro #3: High Contribution Limit
Once you’re contributing enough to a take full advantage of your 401k matching, it’s time to raise your contribution amount each year.
For 2015, the annual allowable 401k contribution limit has been increased to $18,000, or $24,000 if you’re over age 50. While that might seem like a lofty goal if you’re just starting out, you should aim to set aside no less than 10% to 15% of your gross income for retirement.
If you’re a high earner, make sure that your plan will stop taking contributions once you hit the annual limit. If not, you can avoid contributing too much by making flat, equal payments. For example, if you’re paid bi-weekly with 26 pay periods in a year, you could contribute $692.30 ($18,000 / 26) from each paycheck to max out your 401k.
Every time you get a cost-of-living raise, a promotion, or a bonus, you’ll add more to your 401k without even thinking about it.
But if you can’t get near the maximum, contribute a percentage of pay instead. Every time you get a cost-of-living raise, a promotion, or a bonus, you’ll add more to your 401k without even thinking about it.
Most plans also have a feature that allows you to automatically increase your contribution percentage every New Year. Go ahead and set this up to increase 1% each year until you reach 15%. That’s a simple way to make sure you set yourself up for a happy and secure retirement—and you probably wont even miss the money.