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Is a 401(k) worth it? Yes, considering these factors

A 401(k) is a powerful and easy-to-enroll retirement account that can significantly increase your wealth and reduce tax liability. But, you’ll want to consider your retirement goals and diversify your investment vehicles accordingly.

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February 22, 2024

6 min. read

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Key takeaways:
  • 401(k)s are offered by employers and often include employer-match benefits that make enrollment an obvious choice for retirement planning. 
  • Tax advantages are especially valuable perks, with traditional tax-deferred 401(k)s and tax-free Roth accounts available to maximize your tax strategy.
  • Diversification is still important. A 401(k) account likely won’t grow enough to cover your retirement expenses without aggressive contributions and strategic planning. 
  • Your 401(k) plan can act as an emergency account in some cases but is otherwise inaccessible without heavy fees until age 59.5.

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      The 401(k) is a tried and true employer-sponsored retirement plan that may offer several benefits like matching contributions and tax advantages. It’s an important part of most retirement plans, but is a 401(k) really worth it?

      Yes, you should take advantage of a 401(k) account. That said, regular 401(k) contributions alone won’t likely fund your full retirement. Diversification is important, and how valuable a 401(k) is to your retirement strategy depends on your goals and several other factors. 

      Explore 401(k) considerations and learn about other wealth-building assets for your retirement below. 

      Pros: Cons:
      • Potential employer-match contributions • 10% early-withdrawal fees, plus taxes, before age 59.5
      • Easy-to-enroll retirement plan • Limited investment opportunities
      • Tax-deferred advantages for traditional accounts and tax-free perks for Roth accounts • Management and fund fees get expensive
      • Significant compound interest growth with early, regular contributions • Income and contribution limits aren’t ideal for high-income earners
      • May provide $1,000 annual emergency financial relief in select situations

      Employer-match benefits

      Many employers that offer 401(k) benefits also provide matching contributions up to a certain percent of your salary. This can potentially double your contributions each month, which benefits compound growth to help you live off interest in retirement

      Skipping these benefits is leaving free money on the table. Even if your 401(k) isn’t a priority in your full retirement strategy, it’s still worth making regular contributions to maximize employer contributions and increase your overall balance. 

      You’d ideally match your employer match limit – typically 4-6% – but even minimum contributions are valuable. If you contribute $100 a month with a full match benefit, your balance will grow to $145,406 in 40 years with a 2% interest rate. 

      Verdict: Employer-match benefits are a unique perk to 401(k) retirement plans that you shouldn’t pass up. It’s essentially free money that grows with compound interest to support your retirement goals. 

      Tax advantages

      One of the largest 401(k) perks is that they’re tax-advantaged. This comes in two flavors – tax-deferred and tax-exempt accounts. 

      Tax-deferred accounts delay your tax payments until withdrawal, like traditional 401(k)s. These are great if you know your income will decrease by retirement, and you’ll owe fewer taxes. You also contribute pretax dollars, so these deductions reduce your taxable income for the year. 

      Tax-exempt plans earn money without a tax obligation. These are your Roth accounts funded with after-tax dollars. Your growth is tax-free, and you can withdraw without worrying about your tax bracket. Though, not all employers offer a Roth 401(k) option. 

      Images explains and provides examples of taxable, tax-deferred, and tax-free assets and accounts.

      Most people benefit from a diversified mix of taxable, tax-free, and tax-exempt assets, but ratios vary based on your finances and goals. 

      High-income individuals usually prefer tax-deferred plans because they reduce their current taxes and expect to be in a lower tax bracket in retirement, when withdrawals will be taxed as ordinary income. 

      Roth accounts are good for moderate earners who expect their income to increase. You can always roll over into another Roth account, like a Roth IRA that may offer additional investment options.

      Verdict: Your 401(k) contributions are tax-advantaged, and you can pay taxes now or later according to your circumstances and goals. Taxable investment accounts are still valuable for diversification, but they won’t help you beat the taxman. 

      Income and contribution limits

      Some retirement assets have income or contribution limits that can impact what accounts are available to you and how beneficial they are for your retirement plan. These limits don’t impact most people, but they make 401(k) accounts less attractive to high-income individuals. 

      The 2024 annual contribution limit is $23,000 – a $500 increase from last year. This also applies to 403(b)s, most 457 plans, and the federal Thrift Savings Plan. 

      Employees aged 50 and older have increased catch-up contribution limits by $7,500 for a total $30,500 annual limit. 

      Graph compares account growth between the 401(k) contribution limit alone and the 401(k) contribution limit plus catch-up contributions over a 20 year period.

      These limits are higher than what IRAs offer at $7,000 in 2024. While nonretirement accounts have no contribution limits, they also miss out on valuable tax advantages. 

      The IRS restricts contributions to an income limit of $345,000 in 2024. This applies to all contributions, including employer-match. 

      If you earn more than $345,000, you can still defer up to $23,000 to your 401(k). However, your employer-match benefit will only apply up to your allowable compensation. So if you make $500,000 and get a full match, up to  4% of your salary, you’ll only earn $13,800 from your employer match, because it stops at $345,000.  

      Verdict: A 401(k) still benefits high-income earners, but consider other investment opportunities once you reach the income and contribution limits. The excess contributions might better serve you in an IRA or non-retirement account.  

      Fees and flexibility

      A 401(k) is easy to get and manage, but it’s not exactly free. Managers charge account fees for their services, and funds also charge investors. Account fees are a disclosed at enrollment, but you might be able to lower fund fees by choosing your own investment funds. 

      List of common 401(k) fees including administrative costs, investment fees, and individual service fees.

      Penalties also apply for early withdrawals before age 59.5. The IRS will charge a 10% early distribution penalty in addition to any owed income taxes on the withdrawal amount. This means your money isn’t accessible or accommodating to life’s ups and downs. 

      There are some penalty exceptions. The SECURE 2.0 Act implemented a hardship withdrawal policy that allows one $1,000 distribution a year with a three-year repayment agreement. 

      Other withdrawal exceptions may apply to:

      • Terminally ill and dead individuals
      • Disabled people
      • Individuals with disaster recovery needs
      • Domestic abuse survivors
      • Those that rollover funds into another retirement account
      • Families having a child by birth or adoption
      • First-time homebuyers
      • Military reservists or service members called to active duty
      • Qualified medical expenses
      • People experiencing an emergency or hardship

      You can also take out a 401(k) loan and borrow up to 50% of your savings in a year (maximum $50,000) without penalties or taxes. You’re on the hook to repay the balance with interest, but all of the funds return to your 401(k). 

      Verdict: Always look into your investment fees to make smart decisions about your contributions and 401(k) funds. You might be able to self-direct your investments to avoid high-cost funds or discuss alternative 401(k) providers and opportunities with your employer. 

      Investment options

      401(k) plans are designed to be as simple as possible, which increases accessibility and financial support for a large portion of the population. The flip side is that investments are streamlined and often fairly limited, which isn’t ideal for experienced investors. 

      Investment fund opportunities typically fall into a specific category, which may include:

      • Large cap stock funds for companies with a market capitalization value over $10 billion.
      • Small cap stock funds for fast-growing companies with a market capitalization value under $2 billion.
      • International funds for companies outside of the country that may offer increased opportunities with varying risk and reward levels. 
      • Money-market funds, including bonds, CDs, and other low-risk debt and cash-equivalent instruments. 
      • Index funds that use passive management to reflect stock market movements for stable returns and low fees.

      Most 401(k) plans are pretty passive, but you can self-direct your investments to align with a specific strategy that better suits your needs. Options are limited, and investment strategies vary based on your risk tolerance and goals.

      • Conservative funds: Designed to avoid risk for slow-steady growth and minimal losses with a focus on bonds, CDs, and other secure investments. 
      • Balanced funds: A moderate-risk strategy that weighs riskier equities for growth with value stocks and bonds for stability.
      • Aggressive growth funds: High-risk strategy that targets growing companies to find the next big player like Apple. This strategy aims for huge returns but requires know-how and often results in volatility.
      • Target-date fund: An all-in-one approach that considers your target retirement date to maximize potential returns early and transition toward conservative funds as the date approaches.

      Verdict: A 401(k) plan isn’t as customizable as other investments, which might increase accessibility for new investors while limiting growth potential for experienced investors. Consider self-directed investments or re-directing some of your contributions to actively managed assets instead. 

      The Playbook take: Is a 401(k) worth it for me? 

      Contributing to your 401(k) is an extremely valuable move because of tax advantages and employer-match benefits. That said, don’t get too cozy and think your 401(k) will cover your golden years. 

      A 401(k) relies on long-term growth with steady contributions to outperform the market and grow your wealth with compound interest. That means it sometimes loses money, and the passive strategy may be far less efficient than other active investments without tax advantages. 

      Learning how to balance your assets to maximize your tax strategy and drive your wealth to new heights is important. With the right tools, advice, and know-how, you can start investing in your retirement lifestyle.

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      About the author

      Theo Katsoulis, CFA

      Head of Investments

      Theo brings an extensive background in Institutional Asset Management. With a B.A. from Villanova University's School of Business, and having passed the rigorous Series 65 and CFA examinations, he brings significant expertise from portfolio management to understanding intricate financial infrastructures. As Head of Investments at Playbook, he ensures consumers receive exceptional diligence and care for their investment portfolios.

      Tanza Loudenback, CFP®

      Editor

      Tanza is a CFP® certificant, writer, and editor. From 2015 to 2021, she was a top-read author and editor at Insider. Her work focuses on helping people make smart decisions with their money and is published by a variety of online publications.

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