Should I be investing in my 401(k)?
What are the pros and cons of investing before/after tax dollars into a 401(k)?
I have heard this many times and it has never made sense. The idea is if your employer matches 3% of your salary, then you (the employee) should only contribute 3% to your 401(k). I guess at a gut check level this might make sense, after all “why should I put in more than The Man?” But, this completely disregards the tax savings of contributions. The tax savings are significant even for modest income earners.
Besides, there may be no easier way to save. It is automatic and the impact on your take home pay is much less than the dollars saved. For those who have difficulty saving, this is often the first place we look. Our suggestion (regardless of matching contributions) is to put in as much as you can afford, plus a little more, up to the maximum.
Yes, especially if your employer matches your contribution. You would be leaving free money on the table by not taking advantage. Consider your tax advisor when determining your contribution method. Roth is typically the best option for younger investors while pre-tax often is the way to go for folks approaching retirement (typically your income tax rate is lower in retirement).
Unless your 401(k) has excessive fees, which is highly unlikely with the new Fiduciary rule around the corner, it's almost always a good idea to invest in your 401(k), especially if there's a match. However, I am not a big fan of after tax contributions. They require extra tax reporting when withdrawing and are only slightly better than a tax efficient taxable account with index funds. The taxable account is more flexible for funding goals pre-retirement too. So max the 401(k) and then opt for a taxable account with index funds instead of after-tax contributions to the 401(k).
Here's some pros/cons for the second part of your question:
Pre-tax dollars have the benefit of reducing your taxable income, tax deferred growth of earnings on those contributions, and ERISA protection. Post-tax dollars have the benefit of tax-free withdrawals (some limitations in qualified plans) and ERISA Protection.
For younger clients with other ways to reduce their taxable income (e.g. itemized deductions or other adjustments), I advocate the after-tax Roth 401(k). It is an excellent vehicle for eventual tax-free withdrawals of your money with no required minimum distributions for the account owner.
As with anything, there are rules that need to be understood and should be included in the context of a comprehensive financial plan created by a tax or finance professional.
I hope this helps.
Everyone will tell you that you should be investing in your 401(k). This is what I wrote three years ago on my blog. I'll pass it along for you today.
- Begin early. Sign up to contribute to your company’s 401(k) the first day at work. Even if you can’t contribute a lot at first, make a contribution and allow the power of compounding work for you over the years. All things being equal, the length of time you allow your earnings to grow has the biggest impact on how much you’ll have at retirement.
Max out your contribution. Force yourself to save and you’ll find that it’s easier than you think to live within your means.
Always max out the company match. Many companies match employee contributions up to a certain percentage. Be sure to take advantage of the company match up to its limit. It supercharges your savings.
Don’t take distributions or loans from your 401(k) until you are retired. Distributions not only reduce the amount you have at retirement, but can cause painful tax penalties.
Create a well diversified portfolio from the choices available to you. This is one of the biggest problems employees have: not knowing how to invest the funds they are saving. Now there is help available from Registered investment Advisors like Korving & Company that specialize in helping people manage their retirement plans, turning your 401(k) into a 401(OK).