Most people know that they should be contributing to a 401(k). Contributions are added to traditional 401(k) accounts before tax, which reduces your income tax bill each year. But there are also a variety of side benefits that your 401(k) is providing you, in addition to the company match. Here are a few additional perks of contributing to a retirement account through your workplace.
401(k) accounts aren’t taxed each year. In addition to your ability to put pre-tax dollars into your 401(k), investment gains held in your 401(k) also aren’t taxed each year, as they are in your taxable accounts. There are no tax consequences, no matter how you invest your 401(k) funds, until you withdraw the money from the account. Within a 401(k), you don’t have to make any long-term versus short-term gain considerations, there’s no difference in the tax treatment between bonds and stocks, and there are no surprise year-end taxes if you have a huge gain in your account.
Money in your 401(k) is harder to spend. Unlike money in your taxable investment accounts, you can't simply sell your investments and withdraw the money out of your 401(k) account. The fact that it requires talking to a third party and filing out forms just to access your money could be enough to deter people from, say, using the funds to make impulse purchases such as buying a TV. Add in the penalties for early withdrawal and the steps required to get a loan from your 401(k), and 401(k)s could really help secure many people’s retirement savings.
401(k) contributions are automatically deducted from your paycheck. When you make deposits via a payroll deduction you have no chance of forgetting or making excuses about why you can't make the contribution this cycle. Everything is done for you, even before you see the money hit your bank account. You are almost semi-forced to save, which in this case is a good thing.
Contribute or you lose the privilege. There's a limit on how much you can contribute to your 401(k) each year. If you don’t contribute the maximum possible amount each year, you are missing out on a valuable tax deferral and cannot roll the unused tax break over to future years. With each passing year the lifetime maximum you could possibly shield from taxes in a 401(k) gets smaller. This nudge to contribute is more powerful than people give it credit for.
401(k)s have limited choices. Many people complain about the lack of fund selection in 401(k) plans. But the decision to have limited choices is made on purpose. Sometimes too many choices can become confusing and make people hesitate to act. 401(k) fund choices are meant to be easy to select, which helps many unsophisticated investors take advantage of the long-term growth of equities. Simplicity is helpful, especially when most of the participants haven’t studied finance.
401(k)s aren't perfect, but they are certainly one of the better investment vehicles for your retirement savings. If you aren't contributing to a 401(k) at work, you are truly missing out, and not just on the 401(k) match.
David Ning runs MoneyNing, a personal finance site aimed at helping others change their habits for a better financial future. He suggests that everyone to sign up for an online savings account to get more out of our hard earned money.