Learn some lesser-known benefits and tips to make sure you'll have plenty of money when you’re ready to kick back and enjoy retirement.

13 minute read

Before I start today’s show. I want to tell you about today’s sponsor. Discover. Discover matches all the cash back. You earn on your credit card at the end of your first year. It’s amazing because Discover’s accepted at 99 percent of places in the United States that take credit cards.  Learn more at discover.com/yes/2020. Milson report limitations apply.

Hey everyone, I’m Laura Adams, your host and personal finance author, speaker, and consumer advocate. Who’s been writing and hosting this show since 2008. My mission is to give you the knowledge, resources.

Motivation to manage your money the best way possible and create a richer life.

New Money Girl episodes are released every Wednesday. And when you’re subscribed to the show, they’ll automatically show up in your podcast app. So be sure to hit the subscribe button in the Apple podcast app or wherever you listen. I can’t believe that Christmas is just a few days away. My husband and I usually travel to see either his family in Alabama or mine in South Carolina, but not this year. We are staying here at our place on the ocean in Vero beach, Florida, which isn’t too shabby. If you know, if I had to be locked down this year somewhere, there are many worse places I could have been. So I am very grateful for having the incredible view and the beach just steps away whenever I want to take a walk or a dip in the ocean.

And as we wind down the year, this is when I always think about my goals and specifically how much I’m putting away in retirement accounts. And I hope that you will spend some time as well reviewing what’s happened with your retirement savings this year, maybe the good and the bad and what you’d like to accomplish next year today’s show is about one of the most well-known and powerful retirement accounts on the planet. The 401k, if you’re fortunate enough to work for a company that offers one or its sister account, which is for nonprofits, it’s called the four Oh three B. These are incredibly valuable benefits that you should always take advantage of. But unfortunately, many people ignore their retirement plan at work because they just don’t understand the rules and they can seem a little confusing at first. Or you may worry about what would happen to your account.

If you left the company or you mistakenly believed that you have to be an investing expert to use one of these retirement plans, that is certainly not true. This podcast will cover seven primary pros and cons of using a 401k. We’ll cover some lesser known benefits, and I’ll give you tips to save quickly. So you’ve got plenty of money when you’re ready to kick back and enjoy. So let’s start out by talking more specifically about what exactly a 401k retirement plan is. Most people have heard of these, even if you don’t have one. As I mentioned, they’re pretty popular. Um, it is a type of retirement plan that can be offered by an employer. And if you’re self-employed with no employees, you can have something similar. It’s an account called a solo 401k. These accounts allow you to contribute a portion of your paycheck or your self-employment income, and then choose various savings and investment options.

It could be CDs, stock funds, bond funds, money market funds, or ETFs, which are exchange traded funds. You get to choose how to invest your contributions in order to accelerate your account growth. And there are traditional retirement accounts, which give you an immediate benefit by making contributions on a pretax basis that reduces your annual taxable income and your tax liability. You defer paying income tax on your contributions, and also on the earnings in the account until you take withdrawals in the future, you might also have a Roth retirement account. This is another option, which requires you to pay tax up front on your contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free, which is an amazing benefit. A Roth 401k or a Roth four Oh three B is similar to a Roth IRA. However, unlike a Roth IRA, there is not an income limit to qualify.

That means that even high earners can participate in a Roth account at work and reap the really nice benefits. So let’s talk about the pros of investing in a 401k or a four Oh three B retirement plan at work. I’ll tell you when I was in my twenties and started my very first job that offered a 401k, I did not enroll in it. I was nervous about having investments with an employer because I did not understand how these accounts worked. Nobody took the time to explain it to me. I didn’t understand what would happen if I left the company, or if the company went out of business, it was a big employer. So it wasn’t likely that they were to, you know, to fold. But I knew that I probably wasn’t going to be without company for the longterm. And so I think that’s ultimately what kept me from participating.

And that was a huge mistake. I want to put your mind at ease about using a 401k, because there are many more advantages than disadvantages. So let’s talk about four primary advantages for using a retirement plan at work. Number one is having federal legal protection workplace retirement plans protected by a federal law called the employee retirement income security act of 1974. And this gets shortened to IHRSA E R I S a. This law sets minimum standards for employers that offer retirement plans and the administrators who manage them. Now, employers are not required to offer a 401k, but if they do, they do have to adhere to the ERISA law. And again, this is kind of a lesser known aspect of having a retirement plan at work, this federal legal protection, it was an acted to protect your and your beneficiaries interests in workplace retirement plans.

So let me give you just some of the protections that IHRSA gives you disclosure of important facts about your plan features and funding a claims and appeals process to get your benefits from a plan, the right to Sue for benefits and breaches of fiduciary duty. If the plan is mismanaged and payment of certain benefits, if you lose your job or the plan gets terminated, additionally, a powerful but lesser known benefit that URISA offers is that you get protection from creditors. So let’s say you’ve got money in a 401k, but you lose your job and you cannot afford to pay your car loan. If the car lender gets a judgment against you, they can attempt to get repayment from you in various ways. Like they can repossess the car, but they cannot get into your 401k or your four Oh three B. They are protected from creditors because of that federal law.

Now there are exceptions when an ERISA plan is at risk, such as when you owe federal tax debts, criminal penalties, or maybe you have an ex spouse under a qualified domestic relations order. And those kind of serious situations, your retirement plan can be cracked open, but that’s it. And your employer does not have access to your funds. And when you leave a job with a retirement account, you have the option to take your vested retirement funds with you. You can do a tax-free rollover to move the money to a new employer’s retirement plan. If you get a new job or you can move it into your own IRA, and that is a tax-free event, if you do it within 60 days, however, be aware that depending on your home state assets in an IRA may not have the same legal protections that you get with a workplace plan.

So just something to think about, if you are concerned about creditors, having those funds stay in a retirement plan at work, even if you left the job could be, you know, the better option. All right. The second benefit of having a retirement plan at work is getting matching funds. Many employers that offer a retirement plan, also pay matching contributions. These are additional funds that boost your account value, and they’re really meant as an incentive for you to participate in the plan. Let me give you an example, your company might match 100% of what you contribute to the plan up to 3% of your income. So if you earn $50,000 per year and contribute 3%, which would be $1,500 to that plan, your employer would also contribute $1,500 on your behalf. So you would have $3,000 and total contributions, and basically you would have received a 100% return on your $1,500 investment, which is pretty fantastic not to mention that you’re probably going to get investment returns on that $1,500 investment. So you’re making more than a hundred percent return, which is amazing. So always set your 401k contributions to maximize an employer’s match. So you never leave that easy money on the table.

Okay. The third benefit:

Of having a retirement plan at work is having a high annual contribution limit. Once you contribute enough to take advantage of any 401k matching, I want you to consider setting your sights much higher by raising your savings rate every year for 2021, the allowable limit remains at $19,500 per year. That’s the amount that you can contribute. If you’re under age 50, if you’re over age 50, you can contribute $26,000 to a 401k or a four Oh three B a good rule of thumb is to save at least 10 to 15% of your gross income for retirement. And most retirement plans have something called automatic escalation. This is a feature that kicks up your contribution percentage. At the beginning of each year. You might set it to increase your contributions by 1% per year, until you reach 15%. That would be a great goal. That’s a really simple way to set yourself up for a secure future.

And the fourth advantage:

Of having a retirement plan at work is getting free investing advice. After you enroll in a workplace retirement plan, you must choose from a menu of savings and investment options. Most plan providers are major brokerages. So think, you know, fidelity, Vanguard, big names, and they’ve got helpful resources. They might have online assessments that you can take and most have free advisors take advantage of the opportunity to get customized advice for choosing the best investments for your financial situation and the best for your age and your risk tolerance. You know, they’re there to help you. And even if you’re having trouble contributing at all, you know, talking to an advisor can really be valuable to help you get back on track in general, the more time you have until retirement or the higher your risk tolerance, the more stock funds you should own in your retirement account.

Likewise, having less time to go until retirement or a low tolerance for risk means that you should own more conservative and stable investments. This could be bond funds or money market funds. You know, this is something that you can get advice about when you speak to an advisor. All right, now let’s talk about cons of investing in a 401k at work while there are loads of advantages. You know, there are definitely some downsides to consider. One is that you may have limited investing options compared to other types of retirement accounts, such as an IRA, or even a taxable brokerage account, your 401k or your four Oh three B may have fewer investment options. You’re not going to find any exotic choices here. You know, you’re, you’re just going to find basic asset classes, including stock bond and cash funds, however, that’s okay. Having a limited investment menu for a lot of people just streamlines your investment choices and minimizes complexity.

So while you’re not going to find anything exotic here, I would think about that as a positive. It really can simplify how you choose the investments in your retirement portfolio. All right, the second downside is that you may have higher account fees due to the administrative responsibilities required by employer sponsored retirement plans. They may charge high fees compared to other plans. And as a plan participant, you have very little control over the fees you have to pay. So one way to keep your workplace retirement account fees as low as possible is selecting low cost index funds or exchange traded funds, ETFs when possible. And the third downside we’ll talk about is that you must pay fees on early withdrawals. This is just an inherent disadvantage of putting money into a retirement account. And it applies to all retirement accounts. You are typically going to be penalized 10% for early withdrawals.

If you take money out before the official retirement age of 59 and a half, plus you typically can’t even tap a 401k or a four Oh three B, unless you have a qualifying hardship, that’s meant to discourage you from tapping accounts so they can keep growing. The takeaway is that you should only contribute funds to a retirement account that you will not need for everyday living expenses. If you avoid expensive early withdrawals, the advantages of using a workplace retirement account far outweigh the downsides. So I hope that as we go into the new year, you will participate in your retirement account next year. If you haven’t been participating this year, if you’re brand new to these accounts, you know, don’t be afraid of them. They really have a ton to offer in terms of tax benefits and incentives. If you have a question about retirement accounts, I would love to hear it. You can always reach me by going to my contactPage@lauradadams.com. You can also call in a question. You can go to the voicemail line by calling (302) 364-0308. Leave your message. 24 seven. I would love to hear from you that’s all for now. I’ll talk to you next week until then happy holidays. And here’s to living a richer life. Money girl is produced by the audio wizard, Steve rookie Berg with editorial support from Karen Hertzberg. If you’ve been enjoying the podcast, take a moment to rate and review it on Apple podcasts.

That’s an easy, free way to show your support and help new listeners find us. You might also like the backlist episodes and show notes that are always available@quickanddirtytips.com

401(k) retirement plan is one of the most powerful savings vehicles on the planet. If you’re fortunate enough to work for a company that offers one (or its sister for non-profits, a 403(b)), it’s a valuable benefit that you should take advantage of.

But many people ignore their retirement plan at work because they don’t understand the rules, which may seem confusing at first. Or they worry about what happens to their account after they leave the company or mistakenly believe you must be an investing expert to use a retirement plan.

Let’s talk about seven primary pros and cons of using a 401(k). You’ll learn some lesser-known benefits and get tips to save quickly so you have plenty of money when you’re ready to kick back and enjoy retirement.

What is a 401(k) retirement plan?

A 401(k) is a type of retirement plan that can be offered by an employer. And if you’re self-employed with no employees, you can have a similar account called a solo 401(k). These accounts allow you to contribute a portion of your paycheck or self-employment income and choose various savings and investment options such as CDs, stock funds, bond funds, and money market funds, to accelerate your account growth.

Traditional retirement accounts give you an immediate benefit by making contributions on a pre-tax basis, which reduces your annual taxable income and your tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.

Roth retirement accounts require you to pay tax upfront on your contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free. A Roth 401(k) or 403(b) is similar to a Roth IRA; however, unlike a Roth IRA there isn’t an income limit to qualify. That means even high earners can participate in a Roth at work and reap the benefits.

Pros of investing in a 401(k) retirement plan at work

When I was in my 20s and started my first job that offered a 401(k), I didn’t enroll in it. I was nervous about having investments with an employer because I didn’t understand what would happen if I left the company, or it went out of business.

I want to put your mind at ease about using a 401(k) because there are many more advantages than disadvantages. Here are four primary pros for using a retirement plan at work.

1. Having federal legal protection

Qualified workplace retirement plans are protected by the Employee Retirement Income Security Act of 1974 (ERISA), a federal law. It sets minimum standards for employers that offer retirement plans, and the administrators who manage them.

ERISA was enacted to protect your and your beneficiaries’ interests in workplace retirement plans. Here are some of the protections they give you:

  • Disclosure of important facts about your plan features and funding
  • A claims and appeals process to get your benefits from a plan
  • Right to sue for benefits and breaches of fiduciary duty if the plan is mismanaged
  • Payment of certain benefits if you lose your job or a plan gets terminated

Additionally, ERISA offers workplace retirement plans a powerful but lesser-known benefit—protection from creditors. Let’s say you have money in a qualified account but lose your job and can’t pay your car loan. If the car lender gets a judgment against you, they can attempt to get repayment from you in various ways, but not by tapping your 401(k) or 403(b). There are exceptions when an ERISA plan is at risk, such as when you owe federal tax debts, criminal penalties, or an ex-spouse under a Qualified Domestic Relations Order.

When you leave an employer, you have the option to take your vested retirement funds with you. You can do a tax-free rollover to a new employer’s retirement plan or into your own IRA. However, be aware that depending on your home state, assets in an IRA may not have the same legal protections as a workplace plan.

2. Getting matching funds

Many employers that offer a retirement plan also pay matching contributions. Those are additional funds that boost your account value.

For example, your company might match 100% of what you contribute to your retirement plan up to 3% of your income. If you earn $50,000 per year and contribute 3% or $1,500, your employer would also contribute $1,500 on your behalf. You’d have $3,000 in total contributions and receive a 100% return on your $1,500 investment, which is fantastic!

Always set your 401(k) contributions to maximize an employer’s match, so you never leave easy money on the table.

3. Having a high annual contribution limit

Once you contribute enough to take advantage of any 401(k) matching, consider setting your sights higher by raising your savings rate every year. For 2021, the allowable limit remains $19,500, or $26,000 if you’re over age 50. A good rule of thumb is to save at least 10% to 15% of your gross income for retirement.

Most retirement plans have an automatic escalation feature that kicks up your contribution percentage at the beginning of each year. You might set it to increase your contributions by 1% per year until you reach 15%. That’s a simple way to set yourself up for a happy and secure retirement.

4. Getting free investing advice

After you enroll in a workplace retirement plan, you must choose from a menu of savings and investment options. Most plan providers are major brokerages (such as Fidelity or Vanguard) and have helpful resources, such as online assessments and free advisors. Take advantage of the opportunity to get customized advice for choosing the best investments for your financial situation, age, and risk tolerance.

In general, the more time you have until retirement, or the higher your risk tolerance, the more stock funds you should own. Likewise, having less time or a low tolerance for risk means you should own more conservative and stable investments, such as bonds or money market funds.

Cons of investing in a 401(k) retirement plan at work

While there are terrific advantages of investing in a retirement plan at work, here are three cons to consider.

1. You may have limited investment options

Compared to other types of retirement accounts, such as an IRA, or a taxable brokerage account, your 401(k) or 403 (b) may have fewer investment options. You won’t find any exotic choices, just basic asset classes, including stock, bond, and cash funds.

However, having a limited investment menu streamlines your investment choices and minimizes complexity.

2. You may have higher account fees

Due to the administrative responsibilities required by employer-sponsored retirement plans, they may charge high fees. And as a plan participant, you have little control over the fees you must pay.

One way to keep your workplace retirement account fees as low as possible is selecting low-cost index funds or exchange-traded funds (ETFs) when possible.

3.  You must pay fees on early withdrawals

One of the inherent disadvantages of putting money in a retirement account is that you’re typically penalized 10% for early withdrawals before the official retirement age of 59½. Plus, you typically can’t tap a 401(k) or 403(b) unless you have a qualifying hardship. That discourages participants from tapping accounts, so they keep growing.

The takeaway is that you should only contribute funds to a retirement account that you won’t need for everyday living expenses. If you avoid expensive early withdrawals, the advantages of using a workplace retirement account far outweigh the downsides.

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About the Author

Laura Adams, Quick and Dirty Tips

Laura Adams, Quick and Dirty Tips

Laura Adams is an award-winning author of multiple books, including Money Girl’s Smart Moves to Grow Rich. Her newest title, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, is an Amazon No. 1 New Release. Laura’s been the writer and host of the popular Money Girl Podcast, a top weekly audio show in Apple Podcasts, since 2008. She’s a frequent source for the national media and has been featured on most major news outlets including NBC, CBS, ABC FOX, Bloomberg, NPR, The New York Times, The Wall Street Journal, The Washington Post, Money, Time, Kiplinger’s, USA Today, U.S News, Huffington Post, Marketplace, Forbes, Fortune, Consumer Reports, MSN, and many other radio, print, and online publications. Millions of readers and listeners benefit from her practical financial advice. Her mission is to empower consumers to live richer lives through her podcasting, speaking, spokesperson, teaching, and advocacy work. Laura received an MBA from the University of Florida. Visit LauraDAdams.com to learn more and connect with her.

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