If you invest in your employer’s 401(k) retirement plan, your earnings grow tax-deferred. That means you can wait to pay taxes until you withdraw them in retirement.
You can also choose target date funds, which offer predetermined investment mixes based on the year you expect to retire. They’re a hands-off way to achieve your investing goals with minimal effort.
Tax Deferral
401(k) retirement plans represent nearly a fifth of the $35.4 trillion total retirement assets. They are also among the most popular investments for Americans, but only some understand how they work.
One important advantage is that 401(k) contributions are tax-deferred. That means your earnings and dividends will grow faster than in a regular investment account because the income isn’t immediately subject to taxes. However, you will eventually have to pay income tax on your retirement withdrawal.
Another benefit is that many employers offer free “match” contributions. That means that for every dollar you contribute to the plan, your employer will add an equal amount – an immediate return on your investment!
Finally, 401(k) plans usually allow participants to invest in higher-return investments such as stocks or stock funds than they can access through a traditional bank account. That may help you beat inflation and achieve a more secure financial future in retirement.
Matching Contributions
Many employers offer a matching contribution program, free money for employees who save enough. Companies may offer a dollar-for-dollar match or a smaller amount, such as 50 cents on the dollar, up to a certain percentage of an employee’s salary. Taking full advantage of a company match can double an investor’s savings.
Investing in stocks is risky, and there are times when stock markets go down. However, history has shown that stocks tend to increase over the long term, so investors must keep a long-term perspective when saving for retirement.
A 401k retirement plan is a great tool for retirement planning, but not everyone can or will participate in one. Other options include individual retirement accounts (IRAs), Simple IRAs and SEP IRAs. For example, a SEP IRA is ideal for self-employed individuals who need to save for retirement on their own without the help of an employer. Unlike 401(k)s, SEP IRAs allow higher contribution limits than traditional IRAs. They also offer portable investment flexibility, meaning they can be moved to another retirement plan or an IRA when an owner leaves an employer.
Attractive Investment Options
A 401(k) plan typically offers a variety of investment options, including mutual funds and company stock. In addition, many employers provide a match for employee contributions. The amount of the game may vary, but it is typically a dollar-for-dollar match up to a percentage of salary.
When selecting investments, it is important to keep fees low. Fees can significantly impact the amount of money you have in retirement. One study found that a 1% price difference can cost you more than $500,000 over 40 years.
As a rule, investing in index funds that are simple to understand and have a long history of reliable performance is best. Actively managed funds often charge higher fees and can fail to deliver consistent, long-term returns.
Flexibility
A 401(k) is one of the most flexible retirement options. It offers higher contribution limits than an individual retirement account (IRA) and typically allows employer contributions such as profit sharing or matching.
Moreover, most 401(k) plans offer professional investment advice, a popular option that can boost your returns by allowing you to make decisions based on the big picture. This guidance can be provided by a target-date fund, financial advisor, or robo-advisers.
Employees may also be able to roll over their employer’s 401(k) into an IRA or save in an alternative employer-sponsored plan such as a Simplified Employer Pension (SEP) or SIMPLE IRA. This flexibility is helpful as it can reduce the fees you pay.
However, it is important to remember that flexibility comes with a cost. 401(k)s often have higher administrative costs than other retirement account types, including IRAs, and require annual compliance tests and filings. Regularly reviewing your retirement savings progress and financial needs is a good idea. Ideally, it would help if you aimed to maximize your employer match and other company contributions.
Retirement Planning
One of the most important factors in retirement planning is saving enough money. The 401(k) plan is one of the most effective tools for this purpose, and employers should consider offering matching contributions to encourage employees to save more.
The 401(k) plan offers various investment options, including stocks, bonds, and cash. Choosing investments appropriate for your financial situation and risk tolerance is important.
Investing in the 401(k) plan provides many benefits that can significantly affect your retirement income. But it’s also important to understand the 401(k) limits and explore other retirement savings strategies.
Whether you’re considering a 401(k), 403(b) or other workplace savings plan, an investment professional can help you maximize your plan. Start planning for your future today.
