401(k) Tips

Is a 401(k) Worth It?

401(k)s are a great way to save for retirement. But are they worth it for you?

5 min read

There’s no question saving for retirement is an essential piece to anyone’s financial strategy. Stashing money away during your working years is the best way to build a sizable nest egg you can live off of during retirement. The most utilized retirement savings vehicle is the 401(k). But with the other available retirement accounts, is a 401(k) worth it? Or should you look into other options to save for retirement?

While 401(k)s are an integral part of the retirement savings landscape, they aren’t for everyone. 401(k)s make it easy to save for retirement through automatic contributions, but they are limited in the investment options they provide. Employer matching contributions can provide a significant boost, but many 401(k)s come with high fees and costs.

It’s important when investing your money you know exactly what you’re putting your money into. So let’s look at some common features of 401(k)s so you can better decide if it’s right for you. We’ll also show you how to check your employer’s individual 401(k) plan so you can compare it with other retirement savings options.

What are the benefits of a 401(k)?

Your company’s 401(k) plan may be one of the best tools to save for retirement. 401(k) plans make contributing to one easy and convenient while helping you come tax time.

Knowing the benefits of 401(k) plans will help you fully take advantage of them, maximize your retirement saving potential, and make sure you’re consistently building wealth.

Automatic Contributions

One of the great things about 401(k) plans is that they are managed by your company’s human resources department or an outside plan administrator. This means your human resources can have your 401(k) contributions taken out of your paychecks automatically.

Automatic contributions make it effortless for you to continuously save for retirement. Because let’s face it, saving for retirement isn’t the most fun thing to do. Without our money automatically doled out to our 401(k), we would inevitably skip months.

When you get your paychecks, your human resources department takes whatever percentage you elect to contribute to your 401(k). Then, taxes, health insurance, and other auto deductions are taken out, and the rest get deposited into your bank account. This ensures you’re saving for retirement no matter what you spend the rest of your money on.

Tax-Deferred Growth

Because contributions to your 401(k) are taken out before taxes are calculated, your overall tax obligation during your working years is much lower.

Additionally, you will be contributing a higher dollar amount towards your 401(k) than you would if contributions were made with after-tax dollars. This is because 401(k) elections are made using a percentage of your income. So, when you elect, say 5% of your income to be sent to your 401(k), that 5% will be a higher amount when using your gross income instead of your net, after-tax income.

This means, the more you get to contribute to your 401(k) while you’re young, the more money you have to take advantage of the compounding interest.

Employer Match

If your employer offers to match a percentage of your contributions, this can add a significant amount towards your retirement savings. The average employer match is about 3.5%. This means your company will put 3.5% of your annual salary into your 401(k) if you do the same. An employer match effectively doubles your money up to the amount they will match. It’s pretty difficult to beat that return on the market!

One minor drawback to some employer’s matching contributions is they may be tied to a vesting schedule. Vesting means you are entitled to the full amount your employer contributed to your 401(k). If you were to quit or get fired before your 401(k) match was fully vested, you could lose the entire amount your employer contributed.

Higher Contribution Limits

If you’re able to, 401(k)s have a higher contribution limit than other retirement accounts. The IRS allows individuals to contribute $19,500 towards their 401(k) in 2021. Additionally, there is a catch-up bonus of $6,500 for those over 50.

Compare that to IRAs and Roth IRAs that only allow $6,000 annually to each, 401(k)s allow you to save a lot more towards retirement.

While the $19,500 contribution limit applies to your individual contributions, the IRS has an even higher limit for overall contributions. Including an employer match, the maximum you can save in a 401(k) in 2021 is $58,000, $64,500 if your over 50.

To fully maximize your 401(k) and save $58,000, you can do what’s called a Mega Back Door Roth 401(k). A Mega Back Door Roth 401(k) is where you maximize your $19,500 individual contributions towards your 401(k), then contribute up to the rest of the $58,000 total limit towards a Roth 401(k). Your employer’s plan must provide Roth 401(k) and after-tax contributions, but it’s a great way to maximize your retirement savings potential fully.

What are the drawbacks of 401(k)s?

While 401(k)s have their many benefits, some aspects of them don’t stack up to other retirement savings accounts.

Limited Investing Options

Compared to what’s available at outside retirement investments firms, 401(k) plans don’t provide many investment options. However, when saving for retirement, there’s more to it than simply putting your money into a 401(k) and forgetting about it.

To adequately build a retirement fund, your money needs to be invested. 401(k) plans provide on average 19 different investment options within their plans. These options include mutual funds, index funds, target-date funds, and bond funds.

In contrast, retirement accounts held with outside retirement institutions like Fidelity and Vanguard offer hundreds of investment funds.

Mandatory Withdrawals

Although not unique to 401(k)s, the IRS requires 401(k)s to begin taking mandatory withdrawals once you turn 72. Mandatory withdrawals are required because the IRS hasn’t received their taxes on the income you contributed to it.

If you fail to withdrawal the minimum amount required, you’ll be hit with a 50% penalty tax each year until that amount is withdrawn from your 401(k).

The only way to keep your money in your 401(k) and avoid penalties is if you’re 72 and older, still working for the company that sponsors your 401(k) plan, and don’t own more than 5% of that company.

However, as mentioned, mandatory withdrawals apply to other retirement savings accounts as well. The only retirement accounts that don’t have mandatory withdrawals are Roth IRAs and Roth 401(k)s.

What are the alternatives to 401(k)s?

If 401(k)s don’t provide you with what you need to reach your retirement goals, you have other options. You can even contribute to a 401(k) and still utilize other retirement savings accounts to get the benefits of each.

Here are a few of the most common alternatives to 401(k)s.

Traditional IRAs

A traditional IRA is funded with pretax dollars, like 401(k)s. You are taxed when you withdraw funds during retirement at the applicable tax rate.

Institutional retirement companies offer IRAs. This means IRAs have access to much more investment options than 401(k)s.

The downside to IRAs is that you can only contribute a maximum of $6,000 per year.

Roth IRAs

Contributions made to a Roth IRA are made with after-tax dollars. The main benefit to this when you withdraw funds during retirement, they are tax-free.

As with traditional IRAs, Roth IRAs have an annual contribution limit of $6,000.

Roth 401(k)s

Provided by an employer-sponsored retirement savings plan, a Roth 401(k) works similarly to a Roth IRA. Contributions are made with after-tax earnings. However, Roth 401(k)s are subject to the much higher contributions limits 401(k)s.

Roth 401(k)s are limited by the investment options the company’s retirement plan provides.

Rollover your old 401(k)s

Regardless of whether you only have a 401(k), an IRA, or you have both, it’s essential you roll over your old 401(k)s into your current one.

Actively managing your old 401(k)s helps you monitor its progress, reallocate the funds to better meet your goals, and prevents you from losing it.

You can rollover old 401(k)s into your current 401(k) or you can roll it over to an IRA you have with an outside institution.