About 78% of the employers in the U.S. who offer 401(k) retirement plans provide matching contributions, according to the Investment Company Institute (ICI). A match means that for every dollar an employee contributes to their plan, their employer contributes a matching amount, usually 50% or 100% of the employee's contribution -- up to a limit. In most cases, companies match between 50% and 100% of employee contributions up to 4% to 6% of the employee's salary, although some plans contribute more. In other words, if you make $75,000 and contribute 5% of your salary with a company that offers a 100% match, then you contribute $3,750 annually, and your employer pitches in another $3,750.
But what if your employer is among the 22% that don't provide any match? Is it still a good idea to invest in your 401(k)? Generally speaking, yes, for four main reasons.
4 reasons 401(k)s are great retirement savings vehicles
First off, it's critical to save for retirement. Social Security benefits, even with a recent cost-of-living adjustment, will average just $17,532 next year, so a comfortable retirement is likely to require your own savings.
Second, 401(k)s allow you to save for retirement pre-tax, which reduces your tax bill and could put you in a lower tax bracket. Your savings grow untaxed throughout the years and are only subject to income tax when you withdraw funds from the 401(k).
Third, the amount Americans are allowed to contribute to their 401(k)s each year is much greater than the limit of the other widely available pre-tax retirement vehicle, the traditional individual retirement account (IRA).
In 2018, for example, the maximum allowed 401(k) contribution for individuals is $18,500. If you're 50 or older, you can save $6,000 more on top of that for a total of $24,500. With an IRA, the maximum is $5,500 if you're under 50 and $6,500 if you're 50 or older.
When it comes to retirement savings, the more you are able to sock away, the more income you'll ultimately have as a retiree. If you invest $10,000 annually, for example, you'll have $156,455 in a decade's time, assuming an 8% annual return. At the end of 30 years, it will rise to $1.2 million, assuming the same yearly investment and rate of return.
Fourth, employer-sponsored 401(k) contributions can be taken out via payroll deductions. People are 15 times more likely to save for retirement if payroll deduction is available, according to the American Association of Retired Persons (AARP).
But make sure your options are good and your fees are low
That said, there are a couple of things you need to know about your workplace retirement plan before you can decide if it's the best vehicle for your retirement savings.
The first is the investment options on offer. The plan should provide a reasonable range of choices, including stocks, bonds, and money market funds. You should be able to put together a balanced retirement portfolio from the choices you're offered.
The average 401(k) plan offers about 13 stock funds (roughly 10 U.S. funds and 3 international funds), according to the ICI. If your plan offers significantly fewer, you need to consider whether it works for you.
Many companies offer their own stock as an option (or match partly or solely with company stock). While this can be attractive, you want to make sure it's not your only option. Why? If your company underperforms or its industry hits a downturn, then your salary, prospects for advancement, and retirement funds will all be in jeopardy. Diversification can help to prevent a simultaneous hit to all three.
The second area you need to investigate is fees. High fees can erode the performance of a 401(k), just as they can any other investment. While there's no hard-and-fast rule, 401(k) plans average 1% fees, according to the Center for American Progress, while some plans charge much more.
Let's look at three scenarios for fees. Say you began to save $5,000 every year in your 401(k) when you were 30 and did so until you were 65, and the 401(k) earned a 7% annual return, on average. If you never paid any fees at all, you'd end up with $691,000 in your 401(k). However, even a small fee can dramatically reduce your savings over the long run.
If you paid a low fee of 0.5%, that would cost you $71,000 over the course of 35 years, leaving you with $620,000. You'd have to sock away an additional $580 every year to make up for the cost of those fees.
The average fee of 1%? Those fees would eat up $134,000 over 35 years, leaving you with $557,000. If you wanted to make up for those fees, you'd need to save an additional $1,200 annually.
If your 401(k) fees are on the high side, at 1.5%, the fees would knock $190,000 off your savings by age 65, leaving you with $501,000. You'd need to contribute another $1,900 each year to replenish what fees are taking.
Over time, the impact is significant. In fact, 16% of 401(k) plans had fees high enough to offset the tax benefits for younger employees, according to The Yale Law Journal.
There are a variety of fees: administrative and investment fees are the two main categories, although you might also see fees such as commissions if you invest in mutual funds.
Finding the fees is, frankly, not the easiest of tasks. You can start by asking your company's benefits manager what types of fees your 401(k) charges and how much each one would cost you. If you don't get a detailed breakdown, then you may have to dig into your 401(k) fees yourself. Look in the prospectus before investing or in the quarterly statements that 401(k) plan administrators are legally required to send. These are often available online or sent to you electronically.
If you don't have a reasonable range of options, or if the fees could take a big bite out of your retirement savings, all is not lost. No one is required to save in a 401(k) plan, after all.
An IRA is a reasonable alternative
If your options are scant or the fees high (or both), your best alternative for retirement savings might be opening an IRA. There are two types: traditional, which offers the same pre-tax savings advantage as a traditional 401(k), and Roth, which is an after-tax plan, but is not taxed upon withdrawal. (For more on choosing between types of IRAs, here's a guide.)
With a self-directed IRA, you can invest in the mutual funds or stocks of your choosing. You can pick as many funds or stocks as you desire, researching both expected performance and fees to make sure you choose wisely.
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