Is a 401(k) Worth It?

As the prospect of retirement looms larger on the horizon for a substantial segment of Americans, more and more of them are wondering if 401(k) retirement plans are still viable.

These widely-adopted employer-sponsored retirement plans let employees save a fraction of their paycheck for retirement in a tax-advantaged way. In the case of pre-tax 401(k)s, taxes are deferred until withdrawal.

But a pertinent question arises: Is a 401(k) worth it? In this article, we’ll look at the benefits and drawbacks of 401(k) retirement plans, some alternative savings vehicles, and a perspective on whether or not a 401(k) plan aligns with your retirement goals.

Looking for help rolling your old 401(k) into an IRA? Capitalize can help with that — see how it works.

Pros and Cons of a 401(k) Retirement Plan

Let’s take a look at the most favorable aspects of the 401(k) vehicle. Then, we’ll unpack the drawbacks savers should be aware of when strategizing for their retirement savings.

Pros of a 401(k) Retirement Plan

Despite certain limitations, the 401(k) plan presents numerous features that might make it a compelling choice for retirement savings:

• High contribution limits: Relative to other tax-advantaged retirement accounts like IRAs, 401(k) plans boast a significantly higher annual contribution limit, enabling you to set aside a larger sum for when you hit retirement age. For older workers, there are even higher “catch-up” limits to put aside more of your income for an upcoming retirement date.
• Income tax benefits: The contributions to a 401(k) plan are made pre-tax, thus decreasing your current taxable income, and potentially lowering your effective tax bracket in the year you make contributions.
• Employer matching: If your employer offers a company match, you can essentially receive free money towards your retirement savings, accelerating the growth of your nest egg. Employer contributions work differently at each institution, so be sure to ask how they work when starting a new job.
• Delayed payment: Most retirement plans are subject to Required Minimum Distributions (or RMDs), which require retirees to start taking distributions from their account once they reach a certain age. With a 401(k), savers have the option to delay these mandated withdrawals as long as they are still working for the employer sponsoring the plan.
• Emergency loans: In case of an urgent financial need, you may be able to borrow from your 401(k) balance up to $50,000 or 50% of your vested plan balance — whichever is less.
• Reduced taxable income: Contributing to a 401(k) plan lowers your gross income, thereby leading to potential tax savings in the year of contribution.

Challenges of a 401(k) retirement plan

It’s crucial to bear in mind some potential limitations associated with a 401(k) plan:

• Limited investment options: Many 401(k) plans offer a restricted array of investment choices, which could limit your ability to tailor your portfolio in line with your financial objectives and risk tolerance.
• High fees: Some 401(k) plans, especially those run by small businesses, might levy higher fees, which can erode your returns over time.
• Early withdrawal penalties: If you withdraw funds before reaching the age of 59 1/2, you may be subject to a 10% penalty from the IRS, in addition to owing income taxes on the withdrawal amount.
• Lack of personalized investment advice: Many 401(k) participants are left to their own devices when it comes to investment decisions, with minimal guidance provided by the plan providers.
• Ongoing management: 401(k) plans typically require active management and monitoring, which can be time-consuming and daunting for some individuals.

Because 401(k)s have also become a standard benefit from many employers, many workers abandon or forget about old 401(k) accounts — meaning they’re probably missing out on savings.

If you’re looking for options for what to do with your old 401(k), Capitalize can help.

Alternatives to a 401(k)

If the constraints of a 401(k) are a concern, or if you simply want to explore more diversified savings strategies, consider the following alternatives:

Individual Retirement Accounts (IRAs)

Unlike 401(k)s, IRAs are not tied to your employer and offer more flexibility with regard to investment options. Though they have lower contribution limits, they usually come with lower fees. Traditional IRAs allow for pre-tax contributions similar to a 401(k), providing tax-deferred growth.

In other words, once you start to make withdrawals from a tax-deferred IRA, you’ll have to pay taxes on all amounts withdrawn. Recall that these withdrawals will also be taxed at your highest ordinary income tax rate, not the favorable capital gains rate you see with long-term investments held in taxable brokerage accounts.

See our article “401(k) vs IRA” for more help comparing the two different savings accounts.

Roth IRAs

The Roth IRA, a type of Individual Retirement Account, makes an interesting proposition. IRA contributions to a Roth IRA are made with after-tax dollars, but qualified distributions during retirement are tax-free. Like a traditional IRA, Roth IRAs offer a broader range of investment options and offer the same (lower) contribution limit.

For more information on IRAs, see our article “Roth IRA vs. Traditional IRA.”

It’s common for savers to roll their old 401(k) accounts into their active Roth IRAs.

Contact Capitalize if you’re interested in this option.

Real Estate Investment Options

Real estate can be a solid investment option that provides both a potential income stream and price appreciation. However, these investments may require substantial capital, could carry more risk, and may not offer the same level of liquidity as financial investments.

Mutual Funds

Investing directly in mutual funds with a taxable account allows for diversification because they pool money from multiple investors to purchase a broad range of stocks, bonds, or other assets.

While mutual funds offer more choice in investment, they don’t offer the same tax advantages as 401(k)s, and fees can vary greatly by provider.

Target-date funds

Some employers may offer target-date funds or “lifecycle funds” as a retirement savings option for their employees. These are essentially mutual funds with a pre-determined date for the worker to retire.

Considerations for Choosing a 401(k)

Before committing to a 401(k), consider these factors that are unique to every individual:

• Personal financial goals and retirement plans: What does your ideal retirement look like? How much do you need to save for it, and can a 401(k) plan facilitate that?
• Company benefits and matching programs: Does your employer offer matching contributions? How significant are these benefits?
• Investment options and fees: Are the investment options in alignment with your financial goals and risk appetite? Are the fees reasonable and justified?

The Bottom Line

A 401(k) retirement plan can be a powerful instrument in your retirement planning arsenal. While it comes with its share of limitations such as restricted investment options and potentially high fees, the advantages of high contribution limits, tax benefits, and employer matching outweigh the drawbacks for many.

Remember, determining your retirement savings plan depends on many factors, including your financial goals, risk tolerance, and investment knowledge. It’s always recommended to perform your own due diligence or consult with a trusted financial advisor or financial planner before making any significant financial decisions.

If you need assistance in finding and rolling over your old 401(k)s, Capitalize can manage the entire process for you. Get started today.