One of America’s most popular retirement plans has been labeled a scam by critics. While some of their arguments are legitimate, others simply aren’t, for example
- The rich don’t use them
- You can’t touch the money until you’re 59.5.
- They don’t offer significant tax benefits.
The above criticisms are flawed because they frankly don’t make 401(k)s a scam.
401(k)s are not a deliberate attempt to rob anyone of their hard-earned money. Instead, they are plans intended to help you save up for retirement in a diversified investment portfolio. Here are even more reasons why you should contribute to a 401K plan.
Benefits of 401(k)
- Tax advantages: Your contributions are taken straight from your paycheck before income taxes are withheld, thus lowering your taxes. And when you do finally pay tax, in retirement, you’ll be in a lower tax bracket.
- An easy and consistent way to save for retirement through payroll deductions: Saving for retirement is not easy. It would be even more difficult if it were left entirely to you. Would you trust yourself to put aside a consistent amount every month and, in addition, put it into a good investment vehicle? You don’t want to get to 60 and have to postpone retirement because you can’t afford it. So please don’t leave it to chance. With a 401(k) plan, contributions are automatic and done way before receiving your paycheck. You’re therefore less likely to be tempted to spend it. That’s why you should contribute to a 401k plan instaed of relying on yourself.
- The benefit of compound interest: If you start a 401(k) as soon as you enter the job market, time is entirely on your side. The earlier you start your contributions, the more time you have for the money to grow. With time, you’ll start reaping the benefits of compounding, i.e., you’ll begin earning interest, and the interest will also start earning interest.
- Employer match: Some employers offer a ‘matching contribution’ plan in their compensation package. This means that for every dollar you add to the contribution, your employer will match it up to a certain amount. So basically, your employer is giving you extra money. Isn’t this the best reason why you should contribute to a 401k plan?
- You can move it with you: If you happen to change jobs, you have the option to leave it there or take it with you, depending on the type of your plan.
When not to choose a 401(k) plan
I mentioned earlier that there are legitimate arguments against 401(k) plans. Here they are:
- Limited investment options.
- Employer vesting schedules: employers may use 401(k) as leverage to keep their employees from leaving.
401(k) plans are different, some better than others. Many of them contain mutual funds with extremely high fees. Compared to ordinary index funds, these mutual funds lag in performance due to over-management by mutual fund managers.
Before accepting an employer’s compensation package, be sure to assess their terms, fees, investment options, and vesting schedules.
If your employer’s terms are not favorable, here are alternative retirement account options to consider:
- IRA (Individual Retirement Account)
- SEP IRAs for small business owners
- Solo 401(k)s for the self-employed and freelancers
At the end of the day, the merits of having an investment plan outweigh its demerits.
Remember, it’s difficult to work during old age due to decreased energy levels and health issues. You, therefore, don’t want to get to 60, expecting to finally retire, only to realize that you can’t afford to retire.
So don’t leave retirement to chance. Instead, pick the best plan for you and start saving as soon as possible.
Disclaimer: None of this is meant to be construed as financial advice, it’s for educational purposes only. Links may include affiliate referrals and I may receive compensation from partnering websites. The content is accurate as of the posting date but may not be accurate in the future.