Advantages and Disadvantages to 401k Plans
The 401k plan, or “defined contribution plan,” is so called because the amount of contribution is measurable; the amount you receive upon retirement is not measurable. There are advantages and disadvantages to 401kplans. Choosing to invest in this type of plan is entirely up to you. You might want advice of a qualified certified public accountant (CPA) or financial counselor.
Advantages of the 401k plan include:
• Tax Deferred. All savings for retirement in this plan are tax deferred. This means the contribution is taken out before taxes are paid on your paycheck. Taxes will be paid on the amount withdrawn, however.
• You have a choice. You have a choice in how much you contribute; therefore you control how much you are able to save. Your employer may contribute a matching percentage which will help the amount you save grow even quicker.
• Payroll deductions. Most companies will have 401k contributions taken automatically taken out as a payroll deduction. You should also get quarterly reports from the investment company.
• Will not affect Social Security. Your 401k account will have no bearing on the amount of money you will receive from Social Security. Since Social Security was established to help supplement your income, you will want to have another source of income, and a 401(k) can provide that income.
• Your funds are safe. Even if the company you work for files for bankruptcy protection, the money you have contributed is safe. It is held in trust by a separate entity and cannot be touched in case of a bankruptcy. The money vested in your account is yours and remains safe.
• Loans are possible. Because the money in your 401k plan is yours, you may be able to borrow against it in the case of an emergency. Realize that if you do not make regular payments back into the 401k, it will be changed to a distribution and all penalties and taxes will follow.
Disadvantages of having a 401k are varied:
• Loans are possible. While many might think the ability to borrow against your 401k is an advantage, the ease by which you may borrow really makes it a disadvantage. If you fail to repay the loan, you may face stiff penalties and possibly forfeit the remainder of your 401k
• Market driven. Your money, when placed into a 401k, does not have the benefit of being insured. In fact, depending on the investments that you’ve chosen, you could actually lose money while it is tied up in a 401k. If you see that you’re starting to lose money on a particular investment, you might want to consider changing it.
• Limited payout. Unless you have chosen to invest in risky investments, you may not receive the return on your investment that you desire. Most financial counselors will suggest that you spread your investments out between conservative and risky investments.
• Employer limitations. Some employers may not allow you to contribute as much as you’d like. They may also choose not to match your contributions. In either case, you may not be able to save as much as you would prefer.
By looking at the advantages and disadvantages to 401k plans, you can see that much research or advice may be needed before choosing to sign up for the plan at work. A reputable financial counselor can give you the advice you need to make the best decision for your financial goals.