The following article is for entertainment purposes and should not be taken as investment advice. For individualized help, please contact a certified financial professional.
One of the most common bits of feedback I hear from readers of this site is around their 401(k) accounts. They believe that they don't make enough to contribute to one, or they think that the post-tax fees they'll incur in retirement make a 401(k) a waste of money. Today, let's dispel some myths about 401(k) accounts, and why you might want to open one heading into 2023.
Myth #1: 401(k) accounts are only for high earners
Many people believe that 401(k) accounts are only for those who earn a high salary, but this is not the case. In fact, 401(k) accounts are available to any worker who is eligible to participate in their employer's retirement plan. This includes part-time workers and those who earn a modest salary.
It's important to note that while anyone can contribute to a 401(k) account, the amount of money you can contribute may be limited if you have a lower salary. The IRS sets annual contribution limits for 401(k) accounts, and these limits may be lower if you earn less than a certain amount each year. However, even if you are only able to contribute a small amount to your 401(k) account, it's still worth considering this option as a way to save for retirement.
Myth #2: Contributions to a 401(k) account are not tax-deductible
This myth is partially true – contributions to a 401(k) account are not tax-deductible in the traditional sense. However, the money you contribute to your 401(k) account is deducted from your taxable income, which can have a similar effect.
For example, let's say you earn $50,000 per year and contribute $5,000 to your 401(k) account. Your taxable income for the year would be $45,000, which means you would only be taxed on that amount rather than your full $50,000 salary. This can potentially save you thousands of dollars in taxes each year, depending on your tax bracket.
It's important to note that there are limits on the amount of money you can contribute to your 401(k) account and still receive this tax benefit. In 2021, the contribution limit is $19,500 for those under the age of 50 and $26,000 for those 50 and older. If you exceed these limits, you will not be able to deduct the excess contributions from your taxable income.
Myth #3: 401(k) accounts are only for retirement
While 401(k) accounts are primarily used for retirement savings, they can also be used for other purposes, such as paying for higher education or buying a first home. In these cases, you may be able to take a loan from your 401(k) account without incurring any penalties.
However, it's important to note that taking a loan from your 401(k) account can reduce the amount of money you have saved for retirement, so it's important to weigh the pros and cons before making this decision. If you do decide to take a loan from your 401k account, make sure you understand the terms of the loan and how it will affect your retirement savings.
Myth #4: Employers are responsible for managing your 401k account
While it's true that your employer may offer a 401(k) plan and make contributions on your behalf, it's ultimately up to you to manage your own 401(k) account. This includes choosing the investments that you want to hold in your account, monitoring the performance of those investments, and making any necessary adjustments.
Your employer may offer a range of investment options to choose from, such as mutual funds, exchange-traded funds (ETFs), and individual stocks. It's important to do your own research and choose investments that align with your risk tolerance and financial goals. You may also want to consider working with a financial advisor to help you make informed investment decisions.
Myth #5: 401(k) accounts have high fees
401(k) accounts have come under scrutiny in recent years for having high fees that can eat into your retirement savings. While it's true that some 401(k) plans have higher fees than others, it's important to keep in mind that fees can vary significantly from one plan to another. By doing your homework and comparing the fees of different plans, you can find a 401(k) plan that offers a good balance of investment options and low fees.
There are several types of fees that you may encounter with a 401(k) account. These include:
Investment fees: These fees are charged by the investment company for managing the assets in your 401(k) account. They may include expense ratios, which are a percentage of the assets in your account, or load fees, which are a one-time charge when you buy or sell an investment.
Administrative fees: These fees cover the cost of running the 401(k) plan and may be charged to all participants or only to those who have a balance in their account.
Loan fees: If you take out a loan from your 401(k) account, you may be charged a loan origination fee and interest on the loan.
To minimize the impact of fees on your retirement savings, it's important to pay attention to the fees associated with your 401(k) plan and choose investments with low expense ratios. You may also want to consider working with a financial advisor to help you make informed decisions about your 401(k) account.
Conclusion
In conclusion, 401(k) accounts are an important tool for saving for retirement, but there are many myths surrounding these accounts that can cause confusion. By understanding the truth about these myths, you can make informed decisions about your retirement savings and ensure that you are on track to achieve your financial goals.
