Should I Invest in My Company’s 401(k)?
If you’re a working professional, then you likely have the option to invest in your company’s 401(k) plan. You may be wondering if signing up for a 401(k) is a smart move.
Empire Resume will outline what a 401(k) is, its pros and cons, and ultimately whether it’s something you should take advantage of.
What is a 401(k)?
A 401(k) plan is a retirement account that employers offer their employees. It’s named after a section of the United States’ IRS code that establishes these types of accounts.
There are two types of 401(k) accounts: traditional and Roth. They are very similar but differ in how they are taxed.
With a traditional 401(k) you make contributions with pre-tax dollars, which reduces your tax burden for the year. However, you will be taxed when you start taking distributions from the account upon retirement.
With a Roth IRA, you make contributions with post-tax dollars, but don’t have to pay taxes when you start taking distributions.
How Do I Contribute to a 401(k)?
Employees make contributions to their 401(k) through automatic payroll deductions. Typically, a worker can choose to contribute 1% to 15% (up to $19,500 for 2020) of their gross paycheck to their 401(k).
Some employers may match an employees’ contributions up to a certain amount. For example, an employer may match your contributions fifty cents on the dollar or even dollar for dollar up to 4%. You may contribute more than that up to 15% of your income, but it won’t be matched.
The contributions are invested into a combination of mutual funds, employer stock, and other investment vehicles. You can decide on how your money is allocated across these investments. Typically, you’ll choose more aggressive (riskier) investments early in your career and slowly switch to more conservative investments as you approach retirement age.
It’s important to note that the IRS puts limits on how much you can contribute to a 401(k) in a given year. These limits will change from time to time to account for inflation and your age. However, limits are pretty generous, and your tax professional can advise on what those limits are in any given year.
What are the advantages of a 401(k)?
Contributing to a 401(k) has several advantages:
- Tax savings
Your contributions lower your gross income which reduces the taxes you must pay each year.
Also, as your 401(k) grows in value you won’t have to pay gains taxes like you would with interest earned in a bank account or gains made when individual stocks you own grow in value.
Let’s face it. Saving money isn’t easy. With a 401(k) in place, the contributions are taken right from your paycheck. It forces you to “pay yourself first.”
If your employer offers a match, then you should definitely contribute to your 401(k). Think about it. It’s free money over and above your salary and other benefits. Not contributing means you’re just leaving money on the table.
What are the disadvantages of a 401(k)?
Most employees love the simplicity and tax-advantages associated with 401(k) plans. However, there are some drawbacks that you should consider:
- Taxes, eventually
As long as the money is left alone you won’t have to pay taxes. Once you start taking contributions at age 59½ then your money will be taxed according to your current tax bracket.
- Limited investment choices
Hopefully you’ll have a wide selection of index funds, conservative funds, growth funds, bonds, and more. However, you can only invest in the funds that your company chooses and there’s no guarantee you’ll like what’s being offered.
- Higher fees
Your employer’s plan is likely to be heavily regulated. That is good news because these regulations were created for your protection.
But it also means that a certain portion of your money is going towards fees that are baked into mutual fund expenses.
- High penalties for early withdrawal
The money in your 401(k) is meant to be used in retirement so there are rules in place to discourage you from accessing it too soon.
If you try to take money out before age 59½ you’ll be hit with a 10% penalty, plus you’ll have to pay takes. Alternatively, you can take out a loan, but you’ll have a maximum of five years to pay it back with interest.
You may also request a hardship withdrawal for very specific purposes such as medical expenses, funeral expenses, or payments to prevent eviction or foreclosure.
There are no penalties for requesting a hardship withdrawal, but you will have to provide proof of need and you can only borrow the precise amount needed for your hardship.
What’s the bottom line on 401(k)s?
For most employees, a 401(k) is an excellent work benefit. The advantages definitely outweigh the disadvantages.
Here are a few tips to help you get the most out of your 401(k):
- Sign up for your company’s 401(k) plan as soon as you can. The younger you are when you start to save, the better.
- Invest at least enough of your income to maximize the company match. Ideally, try to invest 10% of your gross income into your 401(k).
- Increase your contribution amount every time you get a raise.
- If you change jobs, be sure to roll over your 401(k) to your new employer or into an IRA.
With pensions becoming a thing of the past and social security barely keeping up with inflation, you’ll need another secure source of income in retirement. Unless you are a disciplined saver or a savvy investor, a 401(k) is an excellent way to force yourself to save for retirement.
Dr. Phillip Gold is President/CEO of Empire Resume and has vast experience writing resumes for both professionals and service-members transitioning from the military into civilian roles. He served as a Captain in the U.S. Air Force responsible for leading nuclear missile security. Phillip is a Certified Professional Resume Writer and holds a BA in Communications from The Ohio State University, an MS in Instructional Technology, an MBA in Finance, and a PhD in Finance.