A 401(k) retirement plan is an employer-sponsored retirement savings program that enables employees to save for retirement by making pre-tax contributions. A 401(k) is the dominant retirement plan scheme that most people in the U.S. will use to provide an income once they retire.
If you work at a company that offers a 401(k) plan, take advantage of that retirement savings option. If your company doesn’t offer a plan, or you are self-employed, you should research other options. It’s never too early to start saving for retirement.
Benefits of a 401(k)
Although not perfect, there are benefits of utilizing this type of investment:
- High contribution limits (currently $19,500 per year if 49 years old or younger and up to $25,500 if 50 or older in 2020)
- Income tax benefits include investing with pretax dollars and tax deferred growth on the account until time of distribution
- Possible employer matching
- Loans in the event of an emergency or financial crisis
- Contributions reduce current taxable income
Challenges of a 401(k)
There are, however, some challenges with a 401(k) plan.
- Most plans have limited flexibility as it relates to quality and quantity of investment options.
- Fees can be high especially in smaller company plans
- There can be early withdrawal penalties equal to 10% of the amount withdrawn before age 59 1/2.
In my view, the two biggest issues of a 401(k) plan are that:
- The individual needs to make investment selections by themselves with very little advice or guidance from the plan provider.
- Participants need to monitor and manage their plan over time, again with very little advice or guidance from the plan provider.
Truth be told, most people are not qualified (nor interested in most cases) to choose such investments or to monitor their plan. I highly recommend that if you are taking part in your company 401(k) plan and are not confident in selecting the investments or monitoring it regularly, that you should seek professional guidance.
Notice I said “professional guidance”. Do not seek advice from co-workers even if you think they know what they are doing. Their situation may be much different than yours. I’ve witnessed many make this mistake. I encourage you not to do the same.
Although 401k’s have their weaknesses, I feel the benefits far outweigh the weaknesses. They are a very convenient way to save and invest for retirement.
For more information on this topic, listen to our lengthy discussion on whether people invest and manage their 401(k) investments correctly
Listen to the discussion in two parts:
How do you manage your 401(k) investments? Are you actively managing your investments or are you in the “set it and forget it” category? If you are not doing the most you can to optimize your 401(k) plan investments, contact us to discuss your options.