Is A 401K The Best Retirement Account For You In 2023?

Mar 08, 2023

What is a 401K retirement account?

When it comes to retirement accounts, there is a host to choose from. Is a 401K retirement account the right choice for you? I’m Elijah Bilel with financial anatomy, covering what a 401k retirement account is. Reading not your style? Scroll to the bottom to watch the video!

A 401 K is a type of retirement account. A 401 K is set up by your employer and has tax and savings advantages. Note that this article explains what a 401k retirement account is from the perspective of an employee, not the employer. To illustration what a 401 k is, we will use an example. Here is John who just graduated from college and just got a job as a banker.

 

One of the advantages of this job is 401k matching. So how does 401k matching work? Let’s say John has 80,000 dollars before taxes. He is allowed to put up 6% of his salary into the company 401k program. The company agrees to match 50 cents for every dollar that he contributes.

If John contributes the full amount, he will have 4800 in the account. His company will match this and contribute 2400 dollars. This brings his total contribution up to 7200 dollars. The 4800 that he contributed is tax-deductible. This means that John only has to pay tax on 85,200 dollars. 

One thing to take a look at when checking out a company’s 401k plan is its vesting period. The vesting period is the duration of time that the contribution the company makes to your 401k is locked. Moving back to our example, let’s say John’s company has a 2 year vesting period.

This means he can’t withdraw the companies contributions for 2 years. If John quits his job, is laid off or fired, he gets to keep his contributions and the company’s vested contributions. If John ever withdrew from his 401k before the age of 59 and a half, he will have to pay a 10% penalty as well as taxes on the month.

There are special exceptions such as certain medical expenses and tuition coverage that fall under the IRA’s Hardship distributions and a 401k can be withdrawn from before 59 and a half with no penalties. For more information on what qualifies as a hardship distribution, visit the IRS website.

The 401K has a yearly contribution limit of 19500 dollars for those under 50 and for those over 50, it’s 25500. So how does the 401 k stack up to other retirement account options?



 The Pros

 

1.There is no getting around the fact that it is free money from your employer. Whether it is 401k matching or profit share, you are getting free money and that in itself is a pro.

2. A 401k is also a way to make investing very autonomous. The money is taken out of your paycheck and put into any investment. For those that would rather not deal with the management of the investment, this is a good deal.

3. Lastly, a 401k is a tax-deferred account. You don’t pay taxes when you put money in. You pay taxes when the money is withdrawn. If you are living on less money when you retire, you will be in a smaller tax bracket and likewise will pay less in taxes. So what about the cons?


The Cons 

 

1. Without a doubt, a big con is if you need the money in the account for whatever reason, you can end up paying a 10% penalty. 401K is almost always composed of mutual funds which can present certain issues.

2. It is important to note that your investment options will be limited to what your employer has listed. This can be a big con if they are investing in industries that will soon be obsolete. With limited options also comes fees that mutual funds charge which can be steep. There is always the thought that you could invest yourself and not be paying these fees.

3. Probably the biggest con in a sense is the paying of taxes later. With inflation being what it is, you can end up technically paying more taxes in the future then you would paying them today. 

 


 Is a 401K a good retirement plan for you?



So is a 401K a good retirement vehicle for you? Only you can answer that. If it is, here are some questions you’ll definitely want to find out so you can make the best decision. What’s the match from the company? How long is the vesting period?

What funds are available for you to choose from and how have they performed over the past 10 years? These questions will lead you to your answer. Don't forget to checkout my other articles on the other retirement accounts like what is a Roth 401K, Roth IRA, Traditional IRA and Sep IRA.

 

If you’re looking for more information on personal finance for young adults, you can checkout my free E-book/Audiobook, Steal my financial blueprint. In it, I lay the blueprint that all young people need to implement to ensure that their money is going in all the appropriate places to take care of them, both today and later in life. You get the book here.