To 401k, or not to 401k?

[TheCorporation]

I've heard that 401k plans are great; assuming your employer matches. I've also heard they're a waste and you're better off putting that money into a separate account (ie: Money Market, CD, etc).

Assuming your employer matches 1/2 of your contribution, up to 3% total (You put in 6%, they put in 3%) would it be 'worth it' to utilize the 401k savings plan? I've heard that 401k is a trap, and I've heard it's a great way to save.

Input, opinions, advice, all welcome. Thank you.

[kork13]

401k's are absolutely great options for retirement savings, as long as you recognize and understand that they are just that -- RETIREMENT savings. Many people don't understand that fully, so they might feel it's a "trap" because they are penalized when they try to take money out of their 401k account early (before age 59.5).

If your employer offers any sort of matching on contributions to your 401k, you should absolutely contribute at least up to the point that you receive the maximum allowed match. When your employer matches contributions, you are making an instant 50% profit on your contributions (based on your example). Additionally, 401k contributions are tax deductible, so you will not be taxed on your contributions until you take them out in retirement. In other words, contributing to a 401k will reduce your tax bill during the years that you contribute.

There are very few negatives to participating in a 401k plan. One possible problem could be if your 401k plan has only high-cost investment options, with expenses above 1% of assets. Another concern might be that your 401k plan has a limited number of investment choices, so there is less flexibility in allocating the investments within your account. Otherwise, the only "downside" is that the money you contribute to your 401k is effectively "locked away" until you start to reach retirement age.

ETA: Just want to add one more thought... Even if your employer doesn't match your 401k contributions (mine doesn't, nor does over 25% of companies who offer 401k's), participation in a 401k is STILL worthwhile, because you're still able to reduce your taxable income during the years you contribute. In any circumstances, 401k participation is all around a very smart idea.

[jpg7n16]

I've heard that 401k plans are great; assuming your employer matches. I've also heard they're a waste and you're better off putting that money into a separate account (ie: Money Market, CD, etc).

Well, you're/they're mixing up concepts. A 401k is an account to hold investments. Money market funds and CDs are investments, not accounts.

Why the distinction? Because if your plan allows it, you may be able to hold money market funds and/or CDs in your 401k. Which means that what you've heard doesn't make much sense.

It's more likely that you've talked to some people who are scared of stocks because of 2008, and they think 401k = stocks, which isn't true.


The real question is, where will your income come from in retirement?

Do you have a pension? Most people don't. Will Social Security alone give you the lifestyle you want? Not likely.

So where will the income come from to give you the lifestyle you want? Your savings. You must build up savings for your own future.


Therefore it is necessary to save for your retirement. But where should you put your money?

There are 4 options for accounts to hold your investments.

1) Taxable accounts - These are you normal, bank savings accounts, or taxable brokerage accounts. There's no tax deduction to put your money here. You can buy stocks/bonds/CDs/money market funds/stock funds/bond funds/etc. in them, but your income is taxable each year. Those taxes eat away at your nest egg each year. But as they are not earmarked for retirement, you can use this money at any time for any reason, no penalty.

2) Tax free (Roth) accounts - these don't provide any tax deduction today, but allows your money to grow tax free. All the same investment options apply. So if you want to invest your money, would you like your earnings taxed or not? Those taxes WON'T eat away at this portion of your nest egg, if a Roth is used properly.

3) Tax deductible accounts (401k/403b/Deductible Trad IRA) - these work kinda opposite the Roth. Is your income high this year? Are you paying too much in taxes? These accounts directly reduce your taxable income this year when you add to them. Then all your taxable gains are deferred until you withdraw. So you get a tax deduction, and your employer may even throw in some bonus money to do so (matching contributions).

4) Tax deferred accounts (non-deductible IRA, deferred annuity) - these accounts work just like the #3 tax deductible accounts, except you don't get the tax deduction up front. You just get to avoid having to cash out some of your earnings each year to pay taxes. That lets your money keep working longer, and compounding on larger amounts.


So since it's necessary to invest for your future, which of the 4 types of accounts would you like your money in? 1) An account where part of the income is taxable each and every year, but can be withdrawn any time for any reason, 2) an account where all your gains are tax free, 3) an accounts where you can deduct your contribution to save on taxes, but pay the taxes later in life when you withdraw, or 4) an account where your income isn't taxable each year, but ultimately is taxable.

Depending on your tax situation, most people would pick #2 or #3, followed by the other, then depending on liquidity needs either #1 or #4, followed by the other.


And as your thinking, there's gotta be some trade off for those advantages right? And you're correct. There are income limits, contribution limits, and penalties if you don't use it for retirement.

What's a savvy investor to do? My advice, use a combination of all the accounts.

The best situation to find yourself in, is to have some money you can access at any time, some portion that's growing tax free, and some savings on taxes today.


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Now you've picked your accounts, but how should you invest? Are CDs the way to go? Money market funds?

CDs pay around 1-2% these days. Money markets pay less. So plug in 1-2% return expectation into any retirement calculator and see what happens:

http://apps.finra.org/Investor_Information/Calculators/1/RetirementCalc.aspx

This is a good calculator too:

http://cgi.money.cnn.com/tools/retirementplanner/retirementplanner.jsp

And it lets you pick how aggressive you'd be with your investments. Try it out and see what a good mix might be for you.

[MonkeyMama]

It depends on the specific 401k. There are some pretty terrible 401k choices out there (some of which I'd argue you'd be better off without).

The thing about tax sheltered accounts is they often come with a lot of "catches." So you have to weight the pros/cons of each type account. One consideration in weighing the pros and cons is how long you expect to be with an employer. The cons of 401k plans are generally moot as the average worker does not stay in one place very long, and you can eventually roll it into an IRA (unlimited choices where to invest). So if there is any match involved, is probably worth sucking up high fees/limited investment choices for the short term.

Overall, the advice that 401ks are "traps" and that "CDs or money market accounts would be better" does not sound like sound financial advice.

[grumpter]

Yikes. Even the broke ass small business I work for matches up to 3%. I don't know if I would go for 1/2 match up to 3%. I think it's close to a wash.

[GrimJack]

The match is free money if you just get the full match you are guaranteed a 50% return on your money. How could you even have to think about that for a minute - there is no other possible investment that guarantees 50% return of your investment (legally, I must stipulate legally).

What could possibly go wrong with this kind of return? (no Rube Goldberg okay)

[woodie96]

To go with what Kork said about expenses concerning the investments.
Like the situation where I work. The company matches 100% up to 4%.
So I take my 4% - say 100 bucks..
Add it to their 4% - another 100 bucks and send the 200 bucks off the XYZ 401K.

Unfortunately where I work, most of our funds (16 of 20) are loaded funds around 5 to 6%.

So of the 200 bucks I send to the 401K each month, 188 goes to work for me, and the 401K management team gets 12 bucks.

So all in all, I made 88% on my money for that month.

Yes, I would prefer to keep that 6% in my pocket, but with the choices available, one has to do what they have to do.

IMHO

[PSF]

I'm from Australia, so I must say I don't have full understanding of 401k's, but they are very similar to our superannuation.

The others are right about the 401k being a excellent vehicle for investing for retirement. I also believe it is a good idea to contribute up to the limit of the employer contribution. However I don't think it is a good idea to solely rely on the 401k for your retirement.

The tax status of the 401k may be good at the moment but this can be changed at a whim by the government (if they need a bit more money), and let's face it with the record amount of US debt and the massive amount of government unfunded liabilities, this is possible. The last thing you want is to end up like one of the poor folks over in Cyprus.

so yes the 401k has its place, but remember, don't all your eggs in one basket.

[bUU]

That's much more of a concern with regard to Roth accounts rather than 401(k)'s in general. While surely the government could end the ability to deduct 401(k) contributions, they've never been taxed, so the worst they could do is tax them, which would have happened anyway, eventually. With Roth accounts, there is an expectation that the gains and reinvested dividends would never be taxed, and yes, that could be changed, thereby radically changing the basis on which the decision to fund such accounts were originally made.

Having said that, unless you start very early, it isn't clear that you can fund a typical-length retirement saving only $17,500 per year.

[Anton martin]

401K is for Your Retiremet

I've heard that 401k plans are great; assuming your employer matches. I've also heard they're a waste and you're better off putting that money into a separate account (ie: Money Market, CD, etc).

Assuming your employer matches 1/2 of your contribution, up to 3% total (You put in 6%, they put in 3%) would it be 'worth it' to utilize the 401k savings plan? I've heard that 401k is a trap, and I've heard it's a great way to save.

Input, opinions, advice, all welcome. Thank you.

Well, 401k is for your retirement savings and it is one of the great way to save for your retirement. It make you save for your retirement and keep your savings safe for yourself, so that you can use this money for your retired life. I would suggest that you can go ahead with 401k.