Saving for retirement should be a constant financial priority for everyone.
What Is a 401K?
Before we go any further, we should ensure you understand what we mean when we use the term “401K.” A 401K is a kind of investment account that is specifically geared toward your eventual retirement. Most people want to retire from work at some point, and a 401K is a financial tool that should set you up nicely when you’re ready to do that.
A 401K is similar to an IRA. However, an IRA is a retirement account you open independently. A 401K is a retirement account you set up through your job.
Some employers allow you to set up a 401K with them. To encourage you to contribute to it from your regular paychecks, they may match your contributions up to a certain point.
One of the best arguments for a 401k is that many employers offer “matching funds” to help fund your 401k.
David E. Barfield, CFP, from Datapoint Financial Planning, LLC, says, “Most 401Ks today come with some type of matching contribution from the employer. Increasingly, employers are implementing “safe harbor” 401Ks so that the owners and executives are allowed to make maximum contributions. Therefore, vesting is often immediate, and matching is typically fairly generous. For example, a common safe-harbor match would be 100% of the first 3% and then 50% of the next 2%. That means that if an employee contributes 5%, the company will give them 4%. That’s an 80% match on the first 5% contributed by the employee. 401Ks are notorious for “not so great” actively managed investment options with high expense ratios; however, a match of 80 cents on every dollar up to 5% of your salary can make up for the subpar investment options.”
Jonathon Bird, CFP, CWS, Farnam Financial, warn employees who are taking advantage of their company’s matching to “Be aware of your company’s matching schedule. Sometimes if you front-load your contributions in the first half of the year, your employer won’t provide matching contributions in the second half of the year.”
Christopher Berry, JD, CFP from Castle Wealth Group, cautions against using the 401K too much. He says, “I am always a fan of contributing to a 401k, at least to the employer match. That’s free money. Always take the free money; it’s the best money. However, I would look to contribute to a Roth 401k if it is available. Too often, as I sit down with soon-to-retire families, they have way too much pre-tax money in their 401ks. As they approach retirement, they have this huge tax issue. So, I would say always contribute to a 401k up to the match. Try to do it in a Roth 401k if available. If a Roth 401k is available, contribute as much as possible. If only a traditional 401k is available, contribute to the match, then maybe look at other saving options.”
Remember the Purpose
The important thing to remember about a 401k is that it is money specific for retirement. Barfield says that many of the frustrations with a 401k come from forgetting its purpose.
“Some of the arguments against a 401K involve the lack of access to the money and penalties involved if withdrawing prior to age 59 ½” he says, “A properly funded emergency fund can alleviate much of that anxiety around tying up the money, and the fact that it is tied up makes it more of a pro in my opinion. The money is for RETIREMENT. Most of us with reach “retirement” at some point. That word may mean different things to different people, but if you want financial freedom, you have to save for it…for the long term. A 401K is a great tool for that.”
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