401k retirement plans are among the most powerful means of saving in the world, and if you are lucky to work for a company that offers such financial vehicle, then you might want to take advantage of it. However, many people are ignoring these plans, as they do not understand how they work or just mistakenly believe that they should be an investment expert to use them. Now, to have a good idea about this matter, let us take a look at the pros and cons of 401ks.
List of Pros of 401ks
1. They offer matching funds.
A lot of employers that offer 401k retirement plans also offer matching funds, which can boost the value of your account. For example, these companies would match 100% of the amount of your contribution, which is usually up to 3% of your salary. So, if you are earning $50,000 per year, your contribution would be $1,500, which will be matched by your employer on your behalf, giving you a total of $3,000 in contributions. Free matching of funds will give you a raise for doing nothing, so it is best to set your 401k contributions to maximize your employer’s match, or it will be like leaving easy money on the table.
2. They are under legal federal protection.
Like other qualified workplace retirement plans, 401ks are protected by the Employee Retirement Income Security Act of 1974 or ERISA, which is a federal law that sets minimum standards for employers who opt to set up retirement plans, as well as for the administrators who will manage these funds. Basically, ERISA was imposed to protect your interests when you take out a retirement plan at work, also covering the interests of your beneficiaries. Some provisions of the law include a claims and appeals process that ensures you will receive your benefits; disclosure of important information about your plan’s features; right to sue for breaches of fiduciary duty after mismanagement of the plan; payment of certain benefits if your plan is terminated or if you lose your job; and protection from creditors. So, with legal protection, you need not worry about your employer failing to release your funds or stealing your money if you move on to another job.
3. They come with free financial advice.
Most likely, the provider of your 401k plan offers free professional consultation, so you should take advantage of this opportunity to receive personalized advice and ask questions on your investment options. As you can see, after enrolling in a 401k plan, you are required to choose a means of investing your money from a set of options. Your plan provider also offers terrific resources, such as online assessment, to assist you in figuring out the best investment option for your circumstance. They will be able to suggest a diversified combination of funds that is based on certain factors, such as your age and risk tolerance.
4. They allow for high contribution limits.
Once you have sufficiently contributed to a take full advantage of your plan’s matching with your employer, you can already raise your contribution amount for each year. If you are a high earner, you should make sure that your 401k will stop taking contributions once you have hit the yearly limit. Another solution is to avoid contributing too much by making equal and flat payments. Each time that you get a raise for cost of living, bonus or a promotion, you are adding more to your plan without even thinking about it. However, if you are not able to get near the maximum, you can instead contribute a percentage of pay. Your plan may also have a feature that will allow you to automatically raise the percentage of your contribution every New Year, so you should take advantage of this provision. All these things considered, you will be able to set yourself up for a financially secure and happy retirement, without even missing the money.
List of Cons of 401ks
1. They require early withdrawal fees.
One huge drawback of putting your money in a 401k retirement account is that you will be penalized for taking early withdrawals before you reach the specified retirement age. Mostly, you can take money out of your plan only if you are experiencing financial difficulties. Even so, you will still be required to pay a penalty, which discourages most participants to tap their accounts, though it will keep your retirement funds growing.
2. They come with expensive account fees.
Because of the administrative responsibilities that are required by 401k programs, they are relatively expensive to have. Also, most people with these plans only have little control over the quality of the services they get, which influences the fees that you will have to pay. Now, to keep your account payments as low as possible, it is recommended to choose exchange-traded funds (ETFs) or low-cost index funds when possible.
3. They have limited investment options.
Compared with other retirement accounts, such as IRAs, or other typical taxable brokerage accounts, 401ks have fewer investment options. This entails that if you are looking for investment choices that are outside of the basic asset classes of cash, bonds and stocks, you will not have them. Nevertheless, a limited menu will allow you to minimize complexity and streamline investment decisions.
4. They have structural flaws.
While it is true that investing your money through dollar cost averaging will allow you to prudently build your retirement funds in a trending market, it is not true with a relatively flat, oscillating or trending-down market. So, while it would make sense to purchase more shares of an asset with increasing value, it does not make sense when you buy assets with a full or decreasing value.
All in all, you can make your 401k plan as complex or as simple as you want it to be, but to make sure that you are taking full advantage of it, you should first assess its pros and cons. By doing so, you will be able to learn its lesser-known benefits and gather tips on saving money quickly to secure a good financial future.
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to reach out to contact Natalie, then go here to send her a message.