What are the Pros and Cons of a 401k?
Let’s dive into what is a 401k. A 401k is a tax-advantaged retirement account that is funded by pre-tax deducted contributions. These accounts are typically employer offered.
This post is about the pros and cons of a 401k.
Let’s dive into the top 5 pros and cons of a 401k.
Pros:
1. Tax Advantages
Contributions to a 401k are pre-tax, which means the contributions are deducted from your taxable income. So you’re able to contribute to your 401k without having paid taxes on those contributions (yet). The investments will also grow tax-deferred. That is until you start withdrawing your money. Depending on the income tax bracket you’re at when you first start contributing, this could be very advantageous in lowering your taxable income.
2. Free Money
Otherwise known as employer matches! This is the BEST part about a 401k: when an employer offers matching contributions, which means free money for your retirement. As they always say, do not leave free money on the table!
3. Automatic Contributions
Certainly, the easiest part about investing is to set things on automatic transfer. Which means, the easiest part about contributing to a 401k is the fact that you can automatically get contributions deducted from your paycheck. Easy, convenient, and consistent! Who wouldn’t want that?
4. Investment Options
There are usually plenty of variety of investment options including target funds, individual funds/stocks, etc. Depending on your appetite for risk, you should be able to manage your 401k investments how you see fit.
5. Portability
So, just because your employer offers a match doesn’t mean your 401k is stuck with them! You can always roll over your 401k into a new employer’s plan or an IRA. There are a number of ways to do this, should you choose this route. But yes, a 401k is incredibly portable and you should take advantage of this!
Cons:
1. Early Withdrawal Penalties
If there’s a day you decide you need the money from your 401k, and you’re not 59.5 years old yet, it is likely you will face penalties for early withdrawals.
2. Contribution Limit
Similar to other tax advantaged retirement accounts, there is a contribution limit set every year. This means you can only contribute up to the limit, and if you contribute anything over that amount, you could face penalties as well.
3. Limited Investment Control
While it’s great to be able to invest your money pre-tax, there are certain limitations on the types of investments you can make within this account. It’s typically chosen by your employer in terms of the plan options, funds available, etc.
4. Required Minimum Distributions (RMDs)
People don’t usually talk about this enough, but if you don’t start withdrawing from your 401k once you’re 72, you are required to take minimum distributions.
5. Inaccessibility
Since the 401k retirement accounts are usually an employer benefit, not every employer offers this; therefore, not everyone has access to this type of account.
As you can see, there are a number of pros and cons of a 401k. However, the biggest con in your investing journey is not investing at all. So, regardless of which strategy best suits you (be it a Roth IRA, 401k, etc), the best thing you can do is simply start. Start somewhere!
To reiterate, the top 5 pros and cons of 401k are:
Pros:
- Tax Advantages
- Free Money
- Automatic Contributions
- Investment Options
- Portability
Cons:
- Early Withdrawal Penalties
- Contribution Limit
- Limited Investment Control
- Required Minimum Distributions (RMDs)
- Inaccessibility
There you have it! Interested in learning more about tax advantaged retirement accounts? Check this post out for the Roth IRA pros and cons.
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