What is a 401(k) Plan?

A 401(k) plan is a retirement savings account offered to employees by employers, allowing them to contribute pre-taxed income from their salary towards the 401(k) plan. The invested money then grows tax-free until withdrawal at retirement age.

What are the benefits of investing in a 401(k) Plan?

Benefits of investing in a 401(k) plan include access to employer matching contributions; potential tax advantages; professional asset management and advice; and higher contribution limits than other types of retirement accounts such as IRAs or regular taxable accounts.

Are there any risks associated with a 401(k) Plan?

Yes, there are always risks involved in making any kind of financial investment. The main risk of investing in a 401(k) plan is that the value of your investments can fluctuate due to market conditions and other factors. Additionally, you may incur penalties for early withdrawal before retirement age.

How much can I contribute to my 401(k) Plan?

For 2019, individuals can contribute up to $19,000 per year or up to $25,000 if they are 50 years old or older by the end of the tax year. Contributions are limited to 100% of an employee’s income or $56,000, whichever is less.

Can I withdraw money from my 401(k) Plan before retirement?

Generally speaking, you can only withdraw funds from your 401(k) plan after age 59½ without incurring a 10% early-withdrawal penalty and income tax liability on the amount of the withdrawals. However, there are certain exceptions that may allow for an earlier distribution such as qualifying medical expenses or higher education costs. Be sure to speak with a qualified financial advisor or review IRS regulations to learn more about the specifics of these exceptions.

401(k) Plan Pros and Cons | Finance Strategists

401(k) plans are the most common type of retirement savings plan in the private sector.

They allow employees to save for their retirement on a tax-deferred basis and also count as an asset on the employer's balance sheet.

But while these plans have many advantages, they also do have some drawbacks that prospective employers and participants should know about.

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Here is a list of the pros and cons of 401(k) plans.

Advantages of 401(k) Plans

Traditional 401(k) plans allow plan participants to defer a portion of their earnings on a pretax basis and defer taxation on plan distributions until retirement

Roth 401(k) plans allow participants to make after-tax contributions and take tax-free distributions until retirement

Plan participants can receive matching employer contributions that increase their plan balances over time and boost the rate of return that they get on their money

The money that is held inside a 401(k) plan is now exempt from seizure by creditors

401(k) plans are portable. Employees can now roll their 401(k) plan from a previous employer into the 401(k) plan offered by their new employer, provided that the new plan accepts rollovers (which most do). Employees can also roll their plan into an IRA without incurring taxes.

Employees can often buy shares of company stock inside their 401(k) plans. Many employers also match their employees' contributions with shares of company stock instead of cash

When an employee retires, he or she can spin off all of the shares of company stock from the rest of their plan and sell them in a single special transaction that qualifies for capital gains treatment. This is done under the Net Unrealized Appreciation Rule (NUA)

Many employers offer a broad range of investments to choose from inside their plans, including stocks, bonds, mutual funds, annuities, guaranteed investment contracts and money market funds.

401(k) plans are listed as an asset on the employer's balance sheet

401(k) plans can serve as a tool to attract and retain quality employees, especially if the plan has a vesting schedule (see below)

Some 401(k) plans allow employees to take out a loan against their 401(k) balance up to a certain amount, such the lesser of 50% of the current plan balance or $50,000

401(k) plans must be administered by a plan fiduciary, which means that the administrator must be careful to provide unbiased, high-quality service and administration of the plan

Disadvantages of 401(k) Plans

Plan administration can be expensive for employers, especially for smaller plans

Many plans charge participants an assortment of fees and expenses, such as administrative expenses that are levied on an annual basis.

Many investment choices, such as mutual funds and annuities, may also charge additional investment management fees that are levied on a monthly, quarterly or annual basis

Many variable annuities that are found in a large percentage of 401(k) plans can charge annual fees as high as 2-3%, after factoring in additional fees charged by the annuity on top of any plan fees

Any distribution taken from a 401(k) plan is taxed as ordinary income, which means that it will be taxed at the participant's top marginal tax rate

Any distribution that is taken before the participant is 59 ½ years old will be assessed a 10% early withdrawal penalty, unless a qualified exception applies

The investment choices inside a 401(k) plan are always preselected, so there is a limit on what a participant can invest their money in (although this is changing, as many plans now allow participants internal access to a full-service brokerage account)

Any unpaid loan amount from a 401(k) plan that is not repaid within 90 days of the employee leaving the company will be automatically coded as a regular distribution, with tax and possibly an early withdrawal penalty applying

401(k) Plan Pros And Cons FAQs