Taking the Long View
How many times have you heard that investing is a marathon, not a sprint? It’s true, especially for those embarking on a run along Route 401(k).
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Young professionals have a real friend in the 401(k). Described as a consistent, disciplined way to save for retirement, these employer-sponsored accounts can be a gift that keeps on giving, especially for anyone who develops a stiff upper lip in less-than-optimal economic conditions.
The benefits of a 401(k), named for the section of the tax code that governs them, start with tax advantages and compounding growth, but continue with employer matches, investment flexibility, portability in the form of rollovers, and the potential for loan and hardship withdrawals. After health benefits, this program is among the most valuable benefits that employers can use to gain an edge in recruitment and retention.
In this look at the personal bottom line, we delve into the many advantages of 401(k)s for plan participants (employees), the opportunities for employers (plan sponsors), and the responsibilities of plan administrators who believe it’s never too late or too early to start saving.
“That said, it’s a lot easier to achieve a financially secure retirement by saving a little bit over a long period of time than it is to try saving large amounts of money in a short period of time,” said wealth advisor Ron Yee, vice president and employee benefits group manager for Johnson Bank Wealth Management.
Tax me later
Money placed in a 401(k) is tax-deferred, both the income deferred and the compounded growth – until dispersed at retirement. Financial advisor Andrea Paff, first vice president and a member of The Droster Team at RBC Wealth Management, noted that time is an ally when compounding growth on a tax-deferred basis. “If you are in the 25% federal tax bracket, that means for every dollar you put in your 401(k), you are taking 25 cents away from the IRS and putting it back into your own pocket to grow on a tax-deferred basis over time,” she stated.
Another advantage is that disbursements likely will be taxed at a lower rate in retirement, when income is lower than during the individual’s pre-retirement years. “As they take out that money in retirement, that’s the time at which it’s taxed, but presumably, for most people, the total income they have in retirement is less than they would be taking in before retirement,” noted Brad Mueller, a principal with CliftonLarsonAllen Wealth Advisors. “So they should be in a lower tax bracket.”
The extent to which companies match, and the range of matching options they offer, typically is defined by a single formula, a formula that every employee, executive suite or not, would be subject to. According to Mueller, a common approach would be for an employer to match the first 3% of income the employee defers; in that case, an employee who defers 5% of income would effectively place 8% into his or her account – the 5% deferred plus the 3% company match.