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A 401(k) is a type of retirement plan that allows you to save money and invest in your future. A 401(k) can also be used as an incentive by some employers who will dole out benefits and rewards for employees who participate in the program. But do you really need one? There are many questions surrounding this important decision that should be considered before you do anything.

What is a 401(k)?

A 401(k) is an investment/savings plan that is set up through your employer that is used primarily for retirement. When you do not have a 401(k), it means that the company does not offer any money management services to their employees in regards to retirement plans and investments. A 401(k) is also considered an incentive that employers can give to potential new hires because employers can provide the additional benefit to those who want them.

401(k) Pros

The main benefit of a 401(k) is that it provides a tax-advantaged way to save and invest for retirement. If you opt-in to a 401(k), you can choose how much to contribute from each paycheck, usually done as a percentage. Many employers will also offer to match a portion of what you save to help encourage you to save for retirement. For example, an employer may match 50% of what you contribute up to 6% of your total income. In this case, it could make sense to contribute at least 6% of your income because your employer is essentially giving you free money just to invest in your future.

401(k) Cons

The main drawback to contributing to a 401(k) is that if you access the money before retirement age, you may face heavy penalties. This could be problematic if you need to pay for an emergency or unexpected event before then. Once you contribute to your 401(k), you are still able to take money out of the account, but you will face penalty fees for withdrawing before you reach your retirement age if you are not able to pay it back in a timely manner.

Why Should I Save for Retirement? 

Saving for retirement is important because as you age, your income could begin to decline. Setting aside money could help you continue to live a comfortable life as you age. However, this is not the only reason you should do it! Retirement funds could help protect against emergencies and unexpected situations that may arise during retirement such as an illness or other medical expenses.

How Much Should I Save for Retirement?

The answer depends on what you expect your expenses to be when you retire and how long you are planning on being retired. Along with this, you should also consider whether or not your spouse will be working during retirement or if they will be relying on your retirement income to live. If you want to do the math, check out this retirement savings calculator to see if you’re on track or not. 

401(k) Types

There are essentially two types of 401(k)s: traditional and Roth. Determining which type you should invest in depends on what your employer offers and when you want to be taxed.

Traditional 401(k)

A traditional 401(k) is one in which you do not pay taxes on the money that goes into it until after retirement when you start withdrawing your funds. At this point, you will essentially pay income tax on what you take out to the extent it is considered taxable income.

Roth 401(k)

The Roth version of a 401(k) requires workers to pay their current income tax rate upfront but allows them to withdraw the entire balance of the account without paying any additional fees once they retire. This is beneficial because you don’t have to pay capital gains taxes on the money you withdraw.

Alternatives to a 401(k)

If your employer doesn’t offer a 401(k), or you just would prefer not to use it, there are several other options available that you can use to help set you up for success in retirement.

Traditional IRA

A traditional IRA is a retirement account that will allow you to invest and grow your earnings while deferring when you have to pay taxes. With this type of account, you will only pay taxes when you make withdrawals in retirement.

Roth IRA

A Roth IRA is similar to a Roth 401(k) as it allows you to pay the taxes on your retirement upfront rather than when you withdraw money from the account. A Roth IRA does have an income limit as the IRS in 2021 only allows individuals to contribute if they make $140,000 or less.

Investment Account

Putting funds into an investment account could be a great strategy for growing your wealth through investments like the stock market, mutual funds, or index funds. These accounts can be managed by you or by a financial advisor.

How Can CreditAssociates Help?

If you’re starting to plan for retirement, we recommend taking a look at your debt first. Reducing your debt could help free up some of your income for savings and provide you with a more secure future. If you’re struggling with your debt currently and want to find a way to reduce it—you have options! Our certified debt consultants can walk you through our process to negotiate with your creditors and potentially reduce what you owe by up to half. Give us a call today for a free debt consultation: 1-800-983-6693.

Common Questions About 401(k)s:

Is a 401(k) worth it without matching?

Even if your employer doesn’t offer matching on 401(k) contributions, there can still be value in having a 401(k) account. This is because you can contribute to your account on a pretax basis, which reduces the amount of money that will be taxed when it’s withdrawn from your account upon retirement or other taxable events.

What if my employer doesn’t offer a 401(k)?

If your employer doesn’t offer a 401(k), it is possible to set up a 401(k) on your own. While there may be more paperwork required than if you were to do it through your employer, the benefits of a 401(k) could still make it worth setting up on your own.

How does a 401(k) make money?

A 401(k) makes money by investing in low-risk, high-reward investments such as index funds and bonds. Because the money is invested for you with a professional investor, your risk of losing all your capital is reduced as they will generally put the funds into a diversified portfolio.

How do I take out money from my 401(k)?

Taking money out of your 401(k) is doable, but not advisable before you are 59.5, if you have a Roth 401(k), as you will incur penalties on what you withdraw if you don’t plan to pay it back or it’s not paid back to the account within a certain period of time. With a traditional 401(k), you are able to pull out the principal amount you’ve contributed at 55 or older at any time without penalty.