401k Advantages
Tax Advantages
Perhaps one of the greatest advantages to a 401k is that you don’t have to pay taxes on the current income you put into it until you take it out. This allows you to have more money now, and doesn’t change the actual money you’ll have for retirement.
For example, let's say you wanted to put $2000 towards retirement every year for 30 years. We will assume taxes of 25% and 8% interest gained on your investment per year.
| 401k | Other investment |
|---|
| Taxes | $0 | ($500) |
| Contribution | $2000 | $1500 |
| Tax Shield | $125 | $0 |
| Retirement | $226,566.42 | $169,924.82 |
| Ret. Taxes | ($56,641.60) | $0 |
| AT Retirement | $169,924.82 | $169,924.82 |
You can see that using a 401k as opposed to another type of retirement savings will give you an extra $125 to spend per year (the tax shield). Another factor to consider is that in retirement you will likely be in a lower tax bracket and will therefore have additional tax savings and more retirement money.
Earnings in a 401k account such as interest, dividends, and capital gains aren't taxable and this can result in more savings.
Company Matching
Many companies will match your 401k contributions usually by 30-50%. If your company does this, it’s hard to come up with a reason to invest for retirement elsewhere. A company match of 30% guarantees at least a 30% risk free return on your investment, provided that your portfolio has greater than 0% return. A 30% return is hard to come by, especially in the long run. Of course, most companies have a cap on how much you can invest, and so does the government. If your company matches your contributions, then it would be wise to build up your 401k investments to your contribution limit before considering other retirement investment alternatives.
Automatic Paycheck Withdrawal
Another nice perk of an employer supported 401k is the automatic paycheck withdrawals. Saving for retirement can be hard, especially if you’re young and retirement is decades away. As we know, every year that money is in a 401k account, is another year it can accrue interest—growing at an exponential rate. If you make the decision to give a percentage of each paycheck to your employer, it will greatly ease the temptation of buying something now instead of putting your money away for later. Not to mention it’s also very convenient.
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