Negosentro.com | How To Know When a 401(k) Is Right for Your Retirement Planning, and When It’s Not | For many people, a 401(k) is a major part of their retirement planning strategy, and the majority of full-time employers offer them as a benefit. If you’ve recently accepted a position that comes with a 401(k) option, should you take advantage of it? Often, the answer is yes, but it depends on your financial goals. Read on to learn more about what a 401(k) is, the benefits it offers, and when it’s not the right choice for you.
How Is a 401(k) Different From Retirement Savings?
The chief benefit of a 401(k) is the opportunity to save for retirement without paying taxes at your current tax bracket. When you retire and stop taking a salary, or take a smaller salary, your tax rate decreases and you can pay that lower tax rate on the money you saved years ago when you were making more money. This system helps you save for retirement more quickly. Many people like using a 401(k) plan because it’s an easy way to make sure you save; your employer will automatically contribute to your 401(k) before you even get your paycheck.
If you struggle to save money, this is a great way to short-circuit impulsive spending. Plus, many employers will match your savings up to the $19,500 annual limit on 401(k) contributions. You can still save for retirement in other ways, with what’s left over from your paycheck or any additional miscellaneous income, but you can’t exceed the annual limit until you’re 50 or older. Once you reach that age, you can contribute $6,500 more each year to bolster your retirement planning.
Are There Any Downsides to 401(k) Plans?
There are a few caveats to know before you ask your employer to start contributing the maximum to your 401(k) immediately. Since the purpose of a 401(k) is to incentivize retirement savings, there’s a substantial tax penalty for dipping into your 401(k) early. Typically, there is a 10% penalty for early withdrawals, but the CARES Act passed in March 2020 removed some of those fines for certain circumstances. In general, you shouldn’t put any money into your 401(k) that you think you’ll need before retiring.
Broadly speaking, that means that if you have high-interest debt to pay off or your rainy-day fund is limited, 401(k) contributions might not be the best way to put your hard-earned dollars to work. Childcare, college education, mortgage and rent, and medical expenses not covered by the CARES Act are all common reasons that people make withdrawals from their 401(k)s ahead of time, but doing so will erase the benefits of your earlier savings efforts.
Especially if you know you might have trouble covering unexpected expenses, you should open a general-purpose savings account and accumulate some money for emergencies before you try to build out your retirement fund.
What Other Retirement Plans Should You Consider?
For many people, the $19,500 limit on 401(k) contributions is more than enough to accommodate their retirement planning. Not everyone wants to contribute the maximum amount, either; you may have other life or financial goals that take precedence.
If, however, you’re a diligent saver with a comfortable emergency fund, little to no debt, and enough income to max out your 401(k) plan, you may want to consider adding other savings vehicles to your retirement portfolio, like a traditional or Roth IRA. In the event that you’re unable to contribute to an IRA, or you and a financial adviser determine that it could increase your tax burden, you may want to think about building an investment portfolio. Where you invest depends on your timeline and risk tolerance, but many investments are more fluid than a 401(k), and you’ll be able to use them for major expenses other than retirement without paying a penalty.
Retirement may seem like a distant point in the future, but the sooner you start saving, the more you can enjoy your retirement in comfort. As long as you know you can leave the money where it is, an employer-offered 401(k) plan is a great way to secure your financial future.