Is a 401k worth it?
That answer used to be a no-brainer. After all, 401k plans have been the de facto retirement plan option for years. You may have even set up a 401k at work without giving it much thought.
But if you’re worried about your retirement, you might want to give 401ks closer scrutiny. They’re not right for everyone, and they may not be right for you.
Is it worth it to contribute to a 401k? It turns out that answer isn’t so simple. Here’s what you need to know.
What Is a 401K?
A 401k is a retirement savings vehicle offered to employees. When an employee signs up for a 401k, they agree to have a portion of their pay put into the 401k account. This money is then invested in assets like bonds and mutual funds.
However, not all 401k plans are created equal. Some companies offer no 401k plan, others offer a 401k plan with zero matching, and others offer a 401k plan where the employer matches a percentage of the employees’ contributions (usually capping at a percent, like 5%).
There are two types of 401ks: traditional, and ROTH. The benefits of a 401k depend on which 401k you have.
In a traditional 401k, your contributions are pre-tax, meaning they are taken off of your gross earnings prior to being taxed. This lowers your taxable income, giving you a tax break for the year.
In contrast, a Roth 401k means you are taxed now. That means that when you do retire, your withdrawals are tax-free – as soon as age 59 ½, provided you’ve had the account for at least 5 years.
The good news is that you don’t always have to choose one or the other. Some employees offer both types of plans or will allow you to split your contributions between the two plans.
It’s possible you may start with one plan, then move to an employer who offers a different type of plan. Or you may rollover your funds from a 401k to a different type of account. There’s a difference between rollover and transfer when it comes to managing your assets, so make sure you understand any tax implications.
The Disadvantages of a 401K
401k investment options are limited to what your employer selects. There are also administrative fees, as well as an expense ratio. An expense ratio is a fee used to cover the costs of administrating your assets.
What Are the Alternatives?
One alternative to a 401k is an IRA. They usually have lower fees and offer more investment options. However, there is a $6,000 a year contribution limit (or $7,000 for catch-up contributions for the 50+ crowd) as opposed to $20,500 for 401k plans.
You can also consider a taxable brokerage account. They offer no tax advantages, but you can use the funds whenever you like without withdrawal fees or restrictions.
Is a 401K Worth It?
Is a 401k worth it? In many cases, yes. If your employer offers a good matching contribution rate, and the investment options and plan fees are low, you should be contributing to a 401k.
However, if you can diversify and invest money elsewhere, do that too. You can always mix and match savings plans.
If you found this article helpful, check out our personal finance section for more advice on savings and retirement.