401(k) plans first became common employer-sponsored retirement plans in the late 1970s. Now, millions of workers invest money in these plans over the span of many years to benefit from the perks after vesting. Many employers offer 401(k) plans as a benefit to convince employees to join their company. If you’re wondering if a 401(k) is worth it, read on here for more information from the experts at Cash Factory USA.
What is a 401(k)?
A 401(k) is a type of savings account that allows employees to deposit a portion of your salary into long-term accounts that are used for investments. Most employers match your contributions up to a certain limit. The most important things to remember about this type of retirement plan include:
- It’s eligible for special tax benefits
- Your contribution is limited annually
- Your employer may or may not match your contributions
- The average employer contribution is 50% of employee contribution
- The money is generally invested in mutual funds
- You can’t withdraw the money early
- Withdrawing before age 59 ½ results in a tax penalty
- You pay income tax on these contributions when you withdraw the funds
Many people decide if a 401(k) is worth it depending on whether their employer matches part of their contribution.
As a defined contribution account, the available balance is decided by the initial contributions you make as well as the performance of the investments for which the money is used. Most of the time, the amount of money in a 401(k) is much higher than the amount you originally invested. Once you retire, all that money is entirely in your hands. There are cases where mutual funds are unsuccessful or the stock market takes a hit and your money is compromised. You could experience significant losses in these cases.
Roth 401(k) Variation
One 401(k) option is called a Roth 401(k). Not every employer offers this, but it is becoming increasingly popular. Many people think this 401(k) is worth it because you pay income tax immediately on the contributions. When you retire and start using the funds, you don’t need to pay any more taxes on them.
401(k) Contribution Limits
As of 2019, the most you can put into your 401(k) account per year is $19,000. If you’re over 50, you can add up to $6,000 more. The maximum both you and your employer can contribute together is $56,000 annually. Contribution limits are adjusted every year, so you’ll need to check regularly to ensure you’re putting in the right amount.
401(k) Investment Options
Part of what dictates if a 401(k) is worth it is the investment options offered by your employer. You’ll generally get a choice between a few different financial management advisory groups like Fidelity Investments or The Vanguard Group. You choose which funds you invest your money in. You’ll usually see a number of investment funds, but it’s not out of the ordinary for employers to include foreign funds, real estate funds, index funds, and more.
The most common way to receive your 401(k) funds without penalty is by waiting until they’re vested at age 59 ½. However, there are a number of triggering events that allow you to pull your funds earlier, including:
- Specific Financial Hardship
- Plan Termination
Once the money is withdrawn, regardless of circumstances, it is taxed as ordinary income.
Extended 401(k) Options
Many employees find that the initial investment opportunities their employers offered were very limiting. Once they retire, they may choose to transfer the account balance to a more traditional IRA. The money should go straight from your original account to the new account with no tax implications. If the money is sent to you first, you will owe full income taxes right away, which isn’t worth it for a 401(k) rollover.
Fees and Costs
While some 401(k) accounts are worth it, there are some that get hit with a number of management and legal fees. Some employees found that they owed 30% of their 401(k) portfolio in fees by the time they retired. Carefully review all the terms and conditions of the accounts offered by your employer before agreeing to open one.
Loans from Your Account
Some employers allow you to loan yourself money from your 401(k) account. You could loan yourself up to 50% of the vested amount. Your loan must be repaid within five years and the interest you pay yourself is comparable to the rates charged by other institutions.
While this is just a brief overview of 401(k) plans, Cash Factory USA offers a number of resources for more in-depth analysis and questions. If you’re looking for more details on whether or not a 401(k) is worth it for you, explore our other blog posts for more comprehensive details.