Is Having A 401k Worth It

What Are The Benefits Of A 401k

401 tax benefits are hard to dispute, as they can offer workers a lot of financial security, including:

• Employer match

In fact, let’s dig into 401k benefits a little deeper.

401k employer match

Do you like free money? Good, now that we’ve got that out of the way, a company-matched 401k is basically that. Many employers offer to match employee contributions, either dollar for dollar or 50 cents to the dollar, up to a set limit. So, for example, say you make $100,000 a year and your employer offers a 401k matching of 50% up to the first 6% you elect to contribute. If you contribute 6% of your annual earnings , your employer would contribute an additional 50% of that amount. So, 3,000 free dollars.

It’s up to your employer to decide what percentage they will match, but many companies do offer a dollar-for-dollar match.

401k tax breaks

The tax benefits of 401ks are like the triple-crown of finances. First, contributions are pre-tax. You dont pay taxes on the money until you withdraw it when you retire.

Second, your 401k contributions are not counted as income, which could put you in a lower tax bracket. The result: your tax bill will be smaller for your having squirreled away money for your later years.

401k shelter from creditors

If your finances take a turn for the worst, you won’t have to worry about creditors coming for your 401k. Your qualified retirement plan is protected by the Employee Retirement Income Security Act of 1974 from claims by judgment creditors.

Outlook For The Stock Market Looks A Tad Rocky

After a 10+ year sustained bull market, the market is strong, but inflation has investors worried.

Retired investors could face difficulties if a market correction occurs, even though the losses are likely to be temporary.

As such, there may be an increased demand for investments that offer less risk or downside protection like bonds, lifetime annuities, real asset funds and more

K Savings Potential By Age

The following chart depicts 401k savings potential by age, based on several assumptions. So this is how much you could have saved. These numbers can seem high to many people, especially if you are older and started your retirement savings when the contribution limit was much lower. It can still be used as a guide for your target total retirement savings amounts, including your IRA, Roth IRA, and after-tax savings. While its designed for one person, it can also be used as a guide for a married couple if one spouse decides to no longer work.

The assumptions we used for this chart include:

*Generally, financial planners say the expected rate of return for a 401k is between 8% and 10%.

So, how do you stack up? Are you on the high end? The low end? Do you think these numbers are realistic?

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They Invest In Life Insurance

Cash-value life insurance is another way many people accumulate retirement funds that are tax-deferred and take distributions tax-free. “Most people buy the most insurance for the smallest premium,” Landersman explains. “These premiums, that are thousands or even tens of thousands of dollars each year, grow tax-deferredlike a 401k. In many of these policies, the premiums can be invested in stocks and bond-based accounts.”

Yellen also advises that people put their money into high-cash-value, low-commission dividend-paying whole life insurance. “Your cash value can easily and immediately be tapped for any purpose at all, and your policy can continue growing as though you never touched a dime of it,” she explains.

Like any retirement plan, there could be costly disadvantages to life insurance plans depending on your income and age. Not all retirement options are suitable for everyone. Consult with a financial advisor or retirement expert before making a big decision about your future.

Are 401ks Worth It

The positive things about 401ks are:

However, at the time of withdrawal, your 401k fund disbursements will get taxed and they will be treated as ordinary income under whichever income tax bracket you fall into at that time, with federal tax brackets currently ranging from 10% to 37% .

For anyone whose income tax bracket falls above 20%, this isnt an ideal way to have your full 401K account taxed, because investments gains outside of a 401k would usually be taxed at a capital gains tax rate that would only range from 0-20% for long-term investments. Unfortunately, the IRS treats your entire 401K account as ordinary income, applying a federal tax bracket to all of it that could go as high as 37%. Of course, youll owe state taxes income taxes on it too.

However, I suppose if youre not going to do anything else with your money or youd leave it in the bank without investing it, then using a 401 is better than nothing.

At least then it wont decay in value at the rate of inflation!

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What Is A 401k

A 401k is an employer-sponsored retirement account. It allows an employee to dedicate a percentage of their pre-tax salary to a retirement account. These funds are invested in a range of vehicles like stocks, bonds, mutual funds, and cash. Oh, and if you’re curious where the name 401k comes from? It comes directly from the section of the tax code that established this type of plan specifically subsection 401k.

The Wealthy Dont Use Them

If you were stuck in an elevator with a wealthy person and got to ask them how they amassed their fortune, I guarantee they wont say it came from placing a small fraction of their paycheck into a 401k, allowing someone else to manage it, and waiting until retirement to touch it.

Wealthy people take a different path, which is to invest in income-producing investments throughout their lifespan. As financial guru Grant Cardone explains, wealth is acquired by increasing your income, investing in income-producing assets, and protecting as much of your income a possible.

Put simply, wealthy people rely on three strategies . These are:

As Tony Robbins wisely says, Success leaves clues. By this he means, you should model the people you want to be like. If youre aspiring to be financially free, then you would do well to observe how wealthy people act and use a similar approach to achieve financial freedom yourself.

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Fees And Compounding Costs

The effect of administrative fees on 401s and associated mutual funds can be severe, and these costs can swallow more than half of an individual’s savings. A 401 typically has more than a dozen undisclosed fees, such as trustee fees, bookkeeping fees, finder’s fees, and legal fees. It’s easy to feel overwhelmed when you’re trying to figure out whether you are being treated fairly or being fleeced.

This is in addition to any fund fees. Mutual funds within a 401 often take a 2% fee right off the top. If a fund is up 7% for the year but takes a 2% fee, you’re left with 5%. It sounds like you’re getting the more significant amount. Still, the magic of the fund business makes part of your profits vanish because 7% compounding would return hundreds of thousands more than a 5% compounding returnthe 2% fee taken off the top cuts the return exponentially. By the time you retire, a mutual fund may have taken up to two-thirds of your gains.

Social Security And Medicare Solvency

Social Security and Medicare are in real financial trouble. Policy changes will likely change the future of these programs. Nothing is certain, but if you dive into the numbers, you can see that there are very real concerns about the future of these programs that provide the lions share of retirement income.

While, if you are of retirement age now, your benefits are probably not in peril, future claimants may face reduced benefits.

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What Are The Rules For A Roth Ira

Roth IRAs are only available to people making less than $129,000 a year as an individual, or $191,000 for married couples. They have contribution limits of $5,500 a year, or $6,500 for those over 50. Unlike 401ks and traditional IRAs though, there’s no penalty for withdrawing part of your contribution early.

Eventually You Must Withdraw Money From A 401

Uncle Sam won’t let you keep money in the 401 tax shelter forever. As with IRAs, 401s have required minimum distributions. You must take your first RMD by April 1 in the year after you turn 72. You will have to calculate an RMD for each old 401 you own. Once you’ve determined the RMD, the money must then be withdrawn separately from each 401. Note that unlike Roth IRAs, Roth 401s do have mandatory distributions starting at age 72.

If you hit that magic age, you are still working, and you don’t own 5% or more of the company, you don’t have to take an RMD from your current employer’s 401. And if you want to hold off on RMDs from old 401s and IRAs, you could consider rolling all those assets into your current employer’s 401 plan.

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Weighing Up Your Options

Of course, a 401 retirement plan also has some drawbacks. One of these is restrictive eligibility criteria. You might not be eligible if you work part-time, for example.

Another disadvantage is that as the plan is intended for retirement, you might have restricted access to the funds. Withdrawals might be possible in cases of financial hardship but are accompanied by a financial penalty.

Your employer might also have rules about when their contributions are vested while changing your job might have implications for your participation in your employers plan.

Finally, investment options can be limited, and less orthodox investment choices are often unavailable. You should also factor in fees for the administrator of the plan.

For all these reasons, its crucial you meet with a financial consulting firm before deciding if its the right choice for you.

Limitations And Restrictions On 401s

On the downside, caps are placed on 401 contributions, and IRS regulations limit the allowed percentage of salary contributions. In 2020 and 2021, the maximum contribution to a 401 is $19,500. For someone who makes more than $150,000 per year, contributing the maximum will give them a savings rate of only 12.67%. And the more someone makes above $150,000, the smaller their contribution percentage will be.

The problem is that a savings rate of 12% is probably too low to reach a comfortable retirement. “A savings rate below 10% is definitely too low,” says Andrew Marshall of Andrew Marshall Financial, LLC, in Carlsbad, California. If you’re 50 or over, you can add a $6,500 catch-up contribution to that amount, for a total of $26,000 in 2020 and 2021 , but your money won’t have as long to grow.

Employers can make elective contributions, regardless of how much an employee contributes, but there are limits. In 2022, the limit on total contributions to a 401 from any source is $61,000, rising from $58,000 in 2021. All 401 contributions must be made no later than Dec. 31.

There are also restrictions on how employees can withdraw these assets and when they can do so without incurring a tax penalty. Given these basics of 401s, your 401 is probably not enough for retirement even if you save the maximum amount, and we share three big reasons why.

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Make Savings Part Of Your Budget

If youve recently graduated from school and are entering the workforce for the first time, your current income likely is the most youve ever earned and yet, it still may not seem like enough.

Theres certainly going to be a lot of conflicting priorities, including paying down student loans and saving for an apartment, says Scott Thoma, an investing strategist in St. Louis with Edward Jones. Try to assure youre paying yourself first and allocating money for the future.

Budgeting helps. By keeping track of what money is coming in and whats going out, you may find an extra $50 to set aside for retirement each month. While that may not seem like much, small adjustments can make a difference over time, Thoma says.

We have ways of finding uses for money if its just sitting around, he says. The key is to get into the habit and getting that discipline in place.

Average 401k Balance At Age 65+ $471915 Median $138436

The most common age to retire in the U.S. is 62, so its not surprising to see the average and median 401k balance figures start to decline after age 65. Once you reach age 65, there are still several considerations for your retirement, even if you are no longer working and accumulating wealth. Some of these include making decisions about Medicare, creating a plan around withdrawing money from your retirement accounts, and evaluating any additional insurance needs.

Also Check: How To Get Money From 401k After Retirement

Average Retirement Income From Work:

Work after retirement is becoming an important part of retirement income.

Before the pandemic, the Bureau of Labor Statistics reported that increasing numbers of people over 65 and even over 75 would be remaining in the work force. And, a report from the Transamerica Center for Retirement Studies study found that more than half of workers plan to work in retirement, either on a full-time or part-time basis.

And, 81% of those boomers cite financial reasons the need for retirement income for continuing to work.

However, this research contradicts the headlines reporting on the great resignation, massive numbers of people retiring. And, in fact, Pew Research reports that half of everyone over 55 is now out of the labor force due to retirement.

Is The 401 Dead

The main argument against 401s is that they donât adequately prepare workers for retirement, given so many are behind on savings. A 2019 study found 75% of 401 savers won’t have enough to maintain their lifestyles when they retire.

401s also arenât free: Most come with administrative fees or service charges. The average 401 plan fees total 1% of assets held, according to data from the Center for American Progress. Like savings, costs compound over time. The Department of Labor offers this example:

Letâs say you have 35 years until retirement and a 401 account balance of $25,000 with 7% returns and 0.5% in fees. Your account balance will grow to $227,000 at retirement, without any additional contributions. If your fees are 1.5%, however, your balance will grow to only $163,000. The 1% difference in fees reduces your account balance at retirement by 28%.

Some experts, including Aaron Brown of Bloomberg, argue zero-cost index funds are a smarter option. These passive funds track a broader diversified market, and have minimal fees because they arenât actively managed. While you can invest your 401 in index funds, not every employer will offer the most affordable option with the highest return. Investing in through a brokerage or individual retirement account can mean lower fees, a wider selection of investments and potentially higher yields.

Also Check: Is It Better To Rollover 401k To Ira

Why 401s Are Still Smart

Itâs not fair to blame the 401 for the larger problem of Americans chronically under-saving for retirement, said Hess. In fact, 401s could be the only thing helping them save anything at all. He argues plan features like automatic enrollment, automatic saving increases and default investment into diversified portfolios set savers up for retirement better than going at it alone.

âNone of those features 401s offer are proactively available on do-it-yourself savings platforms unless the investor independently seeks them out, in which case, he or she was probably already on the way to healthy savings behaviors anyway,â he said.

There are additional benefits to 401s. Employers have a fiduciary duty â a legal responsibility to maximize their employeeâs returns, said Hess. Withdrawal fees reduce the temptation to withdraw savings for something else.

â401 are a great place to save, because you lose access and lose control of your savings,â he said. âPeople are often challenged by having too many investment choices, and those who make their own selections tend to underperform. You want your money locked up and growing, undisturbed, for retirement.â

How To Get The Most Out Of Your 401

Stock market volatility can erode retirement savings. If youâre close to retirement age, consider shifting your assets away from stocks to less volatile investments like bonds to protect your money from additional fluctuations. Younger savers have time to recover from losses.

While it may be tempting to stop contributing to your retirement during times of financial stress , resist the urge. You could miss out on valuable future gains if you stop putting money in. If youâre able, contribute more: Just boosting contributions a percentage point can lead to big gains over time. And if your employer offers 401 matching, take advantage of it, or else youâre leaving money on the table.

Other ways to maximize your retirement plan? Avoid withdrawing funds early . If your employer offers multiple investment options for your 401, pick funds with low fees.

If you leave your job, donât forget to roll over your 401 into an IRA â youâll have more investment options and lower fees. We have a guide here.

Some experts, like Ryan, suggest rebalancing your account, a way to manage risk by changing the makeup of your portfolio. Letâs say your retirement plan contained 60% stocks and 40% bonds. If the recent bear market shrunk the stock portion of your account to 50%, you should consider rebalancing by buying equities and selling bonds, he said.

Hess isnât so sure.

Image: Serhat Beyazkayah

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