Planning on Contributing to Your 401(k)? Know These Things First!

• Author: Chris Remington
• Posted: 2024-04-23

If you ask the average person what comes to mind when they think of retirement money, they would probably say 401(k) accounts. After all, more than half of Americans have access to one of these through their workplaces. It can be quite easy to contribute to these; typically, employers take paycheck deductions and put that money into a 401(k).

We've all heard how this money has growth potential over the years you work, but is it any better to use your 401(k) than to take advantage of other "tax-advantaged" accounts on your own? Assess this list of options before making your decision.

Does Your Employer Offer a Match?

Remember, the cap on 401(k) contributions is around $19,000. This is far more money than most of us could afford to contribute. That's why many employers offer to match up to a certain contribution. Often, it's a 1:1 match on up to 6% of your salary. However, it's been an unfortunate and common pattern lately to see employers do a "50% match on up to 6%", leaving their employees even less prepared for retirement.

If your employer doesn't offer a match, you're really not getting any advantages from this type of account over accounts you could open yourself and have more control over.

Do You Have the Self-Discipline to Contribute to Your Own Account?

Though this may not be the easiest question to ask yourself, it's necessary to be realistic. If you're one of those people who will definitely spend the money you can see, it might be best to just let your employer deduct it and put it into an account for you. This is one of the main benefits of 401(k) accounts.

If you do have the self-discipline to accept that you won't be able to use all of the money you're paid, you can look into other options, such as standard IRAs and Roth IRAs.

Look at Expense Ratios

Just because a 401(k) is a "free service" offered by your workplace doesn't mean it's a good idea to use. Quite often, workplace-based services have a very high expense ratio. This means that their plans' earnings tend to be heavily slanted towards fund managers and other financial workers.

In other words, you get far less profits when the funds profit, but you take all the losses as they accrue. Over time, this is a losing strategy. Always check out what the expense ratios are of the funds in which you're invested in your 401(k). Also check for annual fees and other expenses and compare them to plans that are available to you outside the workplace for investment.

High Earner? A Combination Account Is an Option

If you earn far more than the average person, you may have the opposite problem of most people. Perhaps you max out your 401(k) easily every year and are looking for other tax-deferred investment vehicles.

Of course, at this level of income, you would likely not be eligible for a Roth IRA. However, you are likely eligible for a standard IRA. These operate almost identically to a 401(k). One major difference is that you can only contribute a calendar-year maximum of $6,000 in most cases. However, you can withdraw the money earlier and for more reasons than you can with a 401(k).

You can stack an IRA, a 401(k), and any other type of tax-advantaged accounts, like Health Savings Accounts, on top of each other. This will defer the income tax you would have owed on the money until after you withdraw the money. The idea is that you will probably be in a lower tax bracket when you retire, so you should ultimately profit.

Analysis Paralysis

A common issue people face when planning their financial futures is "analysis paralysis". Because there are so many options out there, it can be overwhelming to pick one. This is partially due to fear of missing out on a better deal that you couldn't have known about.

If you find this to be the case during your search, you may want to talk to a financial professional. A CPA or similar can help guide you through investment vehicles and help you come to the conclusion of what the best type of account is for you to get started saving for retirement today!