What are 401(k) plans?
The U.S. Department of Labor defines a 401(k) Plan as a contribution plan that the employee can make contributions from his or her paycheck before taxes are taken out. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions, matching the employee’s contributions up to a certain percentage. SIMPLE and safe harbor 401(k) plans have additional employer contribution and vesting requirements.
Why Should I Participate in the Company 401K Plan? Listed below are some of the biggest reasons to consider participating in your company’s 401(k) program as soon as possible.
Tax Savings: The biggest benefit to all 401(k)s is that they offer pre-tax deposits that reward you for saving money. Since the money goes directly into your retirement account it’s not part of your taxable income, which saves you taxes at the end of the year. You will have to pay taxes on the money when you pull funds out at retirement, but it can grow tax free for several years.
Company Match: Good 401(k) programs come with a company matching contribution. Most companies will match your contributions up to some percentage of your salary. For example, my employer will match 100% of the first 3% of contributions and 50% of the next 2%. So, basically if I contribute 5% of my salary they will contribute an additional 4% for a total. You should ALWAYS contribute at least the amount your employer is willing to match. It’s free money. Not even the best investors can get that kind of return consistently on their investments.
Convenience: Often times we keep telling ourselves that we will do some research and find somewhere to open up a retirement account; however, it keeps getting pushed off and delayed. Your employer can easily have the money deducted out of your paycheck each pay period. If you get started immediately you’ll never even miss the money.
Fees: Good 401(k)s don’t charge a lot of fees: Low fees usually mean higher returns for you over the long haul. Funds that charge higher maintenance fees could cost you thousands of dollars over the course of your work life. These fees are called the “expense ratio”. Just a quick comparison a good ratio is usually under 0.1%. Fees under 0.5% are decent and anything higher probably isn’t a good investment.
In conclusion, if your employer doesn’t match your contributions and all your fund options have higher expense ratios you may want to consider other retirement investment options. However, as a general rule of thumb you should always consider participating in your company 401(k) plan.