What Are The Pros And Cons Of 401k Plan?
Published at : September 21, 2021
1/ It reduces current taxable income:
As an employee participating in any tax-deferred 401(k) plan, your retirement contributions are deducted from each paycheck before taxes are taken out. Since 401(k)s are taken out on a pre-tax basis, it lowers your taxable income, resulting in fewer taxes paid overall.
2/ Employer match is free money that your employer contributes to your 401k plan when you contribute a certain amount to it. There are two types of employer matching: partial match, and dollar-for-dollar match.
3/ High maximum contribution
With Roth IRA and Traditional IRA, you can only contribute $6000 if you’re under 50 and 7000/year if you’re over 50.
But with 401k and Roth 401k you can contribute up to 19,500/year. Keep in mind that If you have 401k and Roth 401k, you can only contribute $19,500/year towards the two plans. So if you want to contribute 10,000/year towards your 401k, you can only contribute 9,500 to the Roth 401k.
4/ You can borrow money from your 401k account without taxes and penalties.
In normal times, you can borrow up to 50% of your savings up to $50,000 within a 12-month period from your 401k account without having to pay taxes and penalties. You still have to pay interest, but that interest still goes back to your 401k plan, so it’s not like it’s going anywhere, But if you default, even though your credit score won’t be impacted, you will have to pay taxes and penalties if you’re under 59.5 years old
So far the 401k plan has offered tremendous benefits for its participants, it gives them reduced taxable income, employer match, high max contribution, and non-taxable money and penalties if you borrow money from it, but what about its disadvantages?
1/ Your distribution is taxed
You already had the luxury to reduce taxable income earlier, now you have to pay back that money when you withdraw it during your retirement.
When you reach 72, you’ll be required to make required minimum distributions (aka RMDs), if you don’t make the RMD, the IRS will take 50% of the amount that you fail to withdraw.
You can calculate the RMD required by heading over to Uniform Lifetime table by the IRS: https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf
2/ Long investment horizon
While you can start distributing your funds from your 401k account when you reach 59.5 years old without penalty. It’s an awfully long time for your money to be in the account if you start contributing at a job after college, your money will be tied up for almost 4 decades.
3/ Limited investment options.
With 401k, your employer may have different investment options already planned out, you don’t have to sit for hours and pick out the funds that you like or sounds sexy like Schwab Emerging Market Equity, or SPDR S&P Dividend, or figure out the companies that you trust will make you money long term.
4/ It has High fees
The fees that you’ll be paying will include things like participant fees, supplemental asset-based fees, service fees like loans, hardship withdrawals, and higher fund expenses.
The funds are actively managed by a manager, so they will charge you fees for their work, they could include management fee, redemption fee, exchange fee, account fee, and purchase fee.
While these disadvantages may make 401k something that most people won’t consider, let’s talk about other reasons why people don’t want to invest in 401k. These are the excuses that are found by Purposeful Finance, they include “I don’t have enough money”, “I’m still paying off debt”, “I’m saving for a house or other major goal”, “I fear future tax increases”, “I have no emergency fund”, “I have poor investment option in my 401k”, “My employer doesn’t offer me free money”.
Me personally, I don’t have a 401k because I’m self-employed and if I work for a company that offer 401k, I may sign up for the free money because after all, that’s the whole point of having a 401k for most people and better retirement of course,, but I will sign up, get the free money from the employer match and focus on maxing out my Roth IRA.
The high fee from the mutual funds is also a factor I’m not really fond of, and I want to have control over my money and Roth IRA allows me to do that. I already made a video talking about the pros and cons of Roth IRA, check it out. And I want to invest in real estate in the future too, and if I put all my money in a 401k plan, I don’t think I’ll be able to do that, but that’s just my opinion.
At the end of the day, it’s up to you to do whatever you want to do with your money, as long as you make smart decisions and you don’t put you or your family in financial trouble, and if you invest for your retirement in the future, then I don’t think it matters what you should do just keep saving your money, investing it, and building your road to financial independence.
As an employee participating in any tax-deferred 401(k) plan, your retirement contributions are deducted from each paycheck before taxes are taken out. Since 401(k)s are taken out on a pre-tax basis, it lowers your taxable income, resulting in fewer taxes paid overall.
2/ Employer match is free money that your employer contributes to your 401k plan when you contribute a certain amount to it. There are two types of employer matching: partial match, and dollar-for-dollar match.
3/ High maximum contribution
With Roth IRA and Traditional IRA, you can only contribute $6000 if you’re under 50 and 7000/year if you’re over 50.
But with 401k and Roth 401k you can contribute up to 19,500/year. Keep in mind that If you have 401k and Roth 401k, you can only contribute $19,500/year towards the two plans. So if you want to contribute 10,000/year towards your 401k, you can only contribute 9,500 to the Roth 401k.
4/ You can borrow money from your 401k account without taxes and penalties.
In normal times, you can borrow up to 50% of your savings up to $50,000 within a 12-month period from your 401k account without having to pay taxes and penalties. You still have to pay interest, but that interest still goes back to your 401k plan, so it’s not like it’s going anywhere, But if you default, even though your credit score won’t be impacted, you will have to pay taxes and penalties if you’re under 59.5 years old
So far the 401k plan has offered tremendous benefits for its participants, it gives them reduced taxable income, employer match, high max contribution, and non-taxable money and penalties if you borrow money from it, but what about its disadvantages?
1/ Your distribution is taxed
You already had the luxury to reduce taxable income earlier, now you have to pay back that money when you withdraw it during your retirement.
When you reach 72, you’ll be required to make required minimum distributions (aka RMDs), if you don’t make the RMD, the IRS will take 50% of the amount that you fail to withdraw.
You can calculate the RMD required by heading over to Uniform Lifetime table by the IRS: https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf
2/ Long investment horizon
While you can start distributing your funds from your 401k account when you reach 59.5 years old without penalty. It’s an awfully long time for your money to be in the account if you start contributing at a job after college, your money will be tied up for almost 4 decades.
3/ Limited investment options.
With 401k, your employer may have different investment options already planned out, you don’t have to sit for hours and pick out the funds that you like or sounds sexy like Schwab Emerging Market Equity, or SPDR S&P Dividend, or figure out the companies that you trust will make you money long term.
4/ It has High fees
The fees that you’ll be paying will include things like participant fees, supplemental asset-based fees, service fees like loans, hardship withdrawals, and higher fund expenses.
The funds are actively managed by a manager, so they will charge you fees for their work, they could include management fee, redemption fee, exchange fee, account fee, and purchase fee.
While these disadvantages may make 401k something that most people won’t consider, let’s talk about other reasons why people don’t want to invest in 401k. These are the excuses that are found by Purposeful Finance, they include “I don’t have enough money”, “I’m still paying off debt”, “I’m saving for a house or other major goal”, “I fear future tax increases”, “I have no emergency fund”, “I have poor investment option in my 401k”, “My employer doesn’t offer me free money”.
Me personally, I don’t have a 401k because I’m self-employed and if I work for a company that offer 401k, I may sign up for the free money because after all, that’s the whole point of having a 401k for most people and better retirement of course,, but I will sign up, get the free money from the employer match and focus on maxing out my Roth IRA.
The high fee from the mutual funds is also a factor I’m not really fond of, and I want to have control over my money and Roth IRA allows me to do that. I already made a video talking about the pros and cons of Roth IRA, check it out. And I want to invest in real estate in the future too, and if I put all my money in a 401k plan, I don’t think I’ll be able to do that, but that’s just my opinion.
At the end of the day, it’s up to you to do whatever you want to do with your money, as long as you make smart decisions and you don’t put you or your family in financial trouble, and if you invest for your retirement in the future, then I don’t think it matters what you should do just keep saving your money, investing it, and building your road to financial independence.
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