401 K : What are the advantages of a 401K investment?

Do you know why some love 401K investments?

401 K is an excellent investment for a lot of people especially high earning individuals. 

You can save 1/3rd of the $18K in taxes assuming you are in 30% tax bracket. You save $6K right away. 

If you have an employer match, you will save that additional amount.

If recession hits at the time of your retirement, your money is exposed to that market, but its the same even if you invest in index funds. You need to have a plan in place to adjust the investment plan as you approach retirement age to minimize big fluctuations in your account i.e. by putting more money in bonds rather than stocks near retirement age. Bonds are more stable than stocks in terms of fluctuation during market ups and downs. Also, you should diversify your portfolio and use other funds too at that time.

During recession time, there’s no investment vehicle, not even life insurance, that isn’t exposed in some way to market forces. 

At retirement, if there is recession, you will still have 1 or 2 decades to live during which the market will recover. If 401K is the only investment you have, then, it is a bad situation. 

401K benefits from compound interest on the profits each year without paying taxes on profits. This is a great advantage. my suspicion is that tax rates will be much higher in the future.

 You will likely have little to no income in retirement age, so you will be in one of the lowest tax brackets. You may actually pay less taxes at that time.  You have to pay taxes on the money either way. With 401k you defer them to the end and get compounding interest benefit without taxes eating into it for 20-40 years or so.

RMDs=Required Minimum Distributions  [removal form 401K] start at 70 years of age. It won’t be a problem if you do not have a lot of money in IRA. You can lower them by making withdrawals and Roth conversions prior to age 70. You can also make Roth contributions to avoid RMDs altogether. Ask some experienced individuals about this. 

Exposure to the stock market has made millions of long-term investors wealthy. No investment out performs the market over time. Markets have fluctuations and that is the reason, one should learn how to diversify portfolio. Buy different kinds of investments rather than confining yourself to buying just a few types. 

Low cost index funds have great diversification and are the best investments. VTSAX in vanguard is one such example. 

Most people advise putting at least up to employer match in 401K. Some employers pay 5% of salary dollar to dollar match in 401K. If you earn a lot and 5% of your salary is $18K, you instantly doubled your money. You can’t beat that. 

I am not a financial advisor. This is not a financial advice. Do your own research before you take any financial decision. 

Read: Things to consider when buying your first home

 

 

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