Is a 401K a Great Way to Save?

April 16, 2020 | by Jacob Hamilton

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If you are fortunate enough to work for a company that offers a 401k retirement plan and you are eligible to join the plan, you ought to do so. A 401k is an excellent way to save for your future, or more specifically, your retirement.

Additionally, if your company's 401k plan has the added benefit of a "company match" program, take advantage of it! Contributing enough funds to your account to garner the maximum matching amount your company offers is like being given free money or a wage increase. No matter what percentage your employer offers to match, it is guaranteed free growth to you. Many companies match their employees' contributions by 50 percent. There are very few arenas in life where such a lucrative return on your investments is offered.

The only exception is that any money you choose to invest in your company's stock will be lost if your company goes bankrupt. Good financial advice suggests you diversify your contributions into several different areas.

Definition of a 401k

This type of retirement savings plan, named for the section in the IRS rules that defines it, is sponsored by the company you work for. Once you become eligible and join, you can contribute money directly from your wages into this specialized account. One of the great benefits of a 401k is that the money you contribute is moved into the account on a pre-tax basis. This is beneficial on two counts: first, you will pay no taxes on the money you put into your 401k until you withdraw it. Secondly, the money you remove from your gross earnings to save in a 401k lowers the amount of earnings reported to the IRS. Thus, you appear to have earned less money than you really did, and your tax rate is lowered. The money in your 401k continues to grow, tax-deferred, until you withdraw it. The third benefit is that in most instances, your employer will match what you contribute. Employers have leeway in the percentages they choose, so you will have to get the specifics from your own company plan advisor. If your employer matches your contribution by 50%, that means that for every dollar you contribute to your 401k, the company will contribute 50 cents. You can choose how much you want to contribute as well, which is an additional benefit, but to receive the maximum benefit of company-matched percentages, you should contribute the maximum allowable amount that you can afford.

Though 401k plans have many similarities to Individual Retirement Accounts, no personal IRA, that is, one not set up by a company, receives matching funds. Additionally, IRAs can have much lower contribution limits. When you have a choice between contributing to a 401k or an IRA, the 401k is usually, but not always, the better option. Some financial experts believe the Roth IRA is better for you if you think you will be in the same or a higher tax bracket when you retire.

The money you contribute is invested exactly how you want it, according to a list of fund options provided to you through your company. That is yet another benefit. If you are young and willing to stand a bit of risk, you can choose to have the money in your 401k invested more aggressively than say, an employee who is nearing retirement and does not want to risk quite as much.

Employees are limited by law as to how much they can contribute to their 401k s each year, the maximum allowed is $15,000 annually.

Those over fifty years old, however, are allowed to contribute more, up to $20,000. This is especially helpful if you're trying to "catch-up" to where you should be in your retirement planning. 401k plans are protected by pension laws. They are even protected from garnishment by creditors, except in the case of domestic relations orders issued by a court of law.

Employees' 401k contributions are deducted automatically from their paychecks (before taxes are withheld) and are invested alongside their companies matching percentages in the ways they specified when they began their 401k contribution. This makes it easy and convenient to save. Additionally, most companies offer comprehensive websites where you can register, monitor, change and examine your 401k account whenever you wish.

Yet another benefit of a 401k is that it can go with you. If you leave your company, you can "rollover" your savings plan, either into a new company's 401k or into a personal IRA account. You can also choose to take the cash, but that defeats the purpose of the 401k altogether.

Start contributing to your 401k the minute you are eligible. The earlier you begin, the more money you will have when you retire. Additionally, the earlier you begin, the more able your account will be to recover from the market's fluctuations. Money experts still recommend the stock market as the number one method of making money if the money can be left alone for a long period of time.

When you reach the age of 59, you can begin withdrawing from your 401k without penalties. Additionally, you'll most likely be in a lower tax bracket than you were when you first began contributing to your savings account in your twenties, so although you do have to pay taxes on the money you withdraw, it will be at a lower rate.

Loans from your 401k

Ideally, you should leave your 401k alone. But there are situations where you might need money, and your 401k is sometimes a better place to get that loan than a bank. This is because you're borrowing from yourself, and when you pay the loan back, you pay yourself back. The interest rate you're charged on the loan is usually low, and it goes to you instead of to the bank. Generally, you will have five years to pay back a loan you take out on your 401k. It's important to note that you cannot borrow the entire amount in your 401k, however. It is usually capped at 50 percent of your vested, balance up to $50,000.

You can borrow from your 401k without penalties before you are 59 if you follow the rules and guidelines and pay the money back (through payroll deduction) within the allowed timeframe. All companies have different rules about what kinds of loans they allow, so you will need to get the specifics from your benefit advisor.

Getting a loan from your 401k is generally easier than trying to get a loan from a bank. If you have bad credit or credit problems, it may be best to get the money you need from your 401k account. Remember, though, that when you take money from your 401k, that money is no longer in your account, growing and earning interest for your retirement years. You may also be subject to various fees.

If you leave your company while you have an outstanding 401k loan, the loan generally becomes due almost immediately. Some companies may give you 60 days, some only 30, to pay back the loan in its entirety; if you don't, your loan is in default and you have to pay taxes and the 10 percent IRS penalty.

Finally, the IRS does not require companies to offer 401k loans. So before you plan how you're going to spend that money, find out if the option is available to you.

What "vested" means

A certain number of years must pass before you own the money that your company matches in your 401k. If you quit your job before you are completely vested, you will lose some of the matched funds and/or interest in your 401k. The money you contribute, however, will always belong to you. Companies who offer 401k s must follow one of two rules.

  • The company must vest the matching funds in a three-year plan, which means the matched funds are owned by the employee 100 percent after three years,

  • the company can use a six-year graded plan, which means that the employee owns 20 percent per year in the second through sixth years.

Ask your company benefit administrator for the details of your company's 401k plan.

Hardship withdrawals

Even if your company does not allow 401k loans, there may still be a way to access some of your savings. Again, find out beforehand from your benefit administrator if hardship withdrawals are a possibility.

If you have a serious, immediate financial need, cannot get the emergency funds anywhere else, only ask for the amount of money you need to satisfy your emergency, and have already taken out the maximum allowed in loan form from your 401k, you might be able to receive a "hardship withdrawal." There are a few conditions placed on such a withdrawal, such as the reason for the request. Some companies restrict hardship withdrawals to medical expenses, a home purchase, or education. Other than that, the withdrawal must be an emergency to keep you from being evicted from your home or some other serious need.

Unfortunately, in a hardship withdrawal situation, you will have to pay taxes and a 10 percent IRS penalty. Unlike a regular loan, a hardship withdrawal cannot be paid back to the account.

Other 401k Withdrawals

Some situations will qualify you to receive withdrawals from your 401k without having to pay the 10 percent penalty fee. For instance:

  • A court of law orders you to turn over funds to a divorced spouse, child or dependent
  • You are laid off, you quit, you are terminated or you retire in the same year you turn 55 or later
  • You experience a total, permanent disability
  • Your medical debts exceed 7.5 percent of your adjusted gross income

One of the benefits an IRA has over a 401k hardship withdrawal is that IRAs offer a lifetime withdrawal exemption of $10,000 for the purchase of a house.

Plan for your retirement

As you think about joining your company's 401k plan, get all the brochures and information you can. Ask your plan administrator any questions you have. Research and understand the various investment opportunities the plan offers, and then keep an eye on your 401k. You can tweak it as needed to earn the most you can.

401ks are generally easy to understand and participate in. Take advantage of yours so that you can reap the benefits later on.

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Jacob Hamilton


With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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