401k’s are the most popular form of additional compensation given to employees by companies. Each 401k plan is different for each company. However, all of them allow the employees to make contributions to various assets. These assets can include index funds, mutual funds, stocks, bonds, and even company stock. In most cases, the employers will even match a certain percentage of the contributions made out of each employee’s paycheck. However, 401k’s offer other advantages as well:
- The power of compounding and deferred taxes.
The main advantage of 401k’s for employees is that you can grow the money in these plans through investing and defer paying taxes on contributions until you withdraw the funds.
- 401k’s are highly portable retirement accounts.
Also, most 401ks are portable allowing you to take them with you once you leave a company. This means you can take the funds and put them in your new company’s 401k without too much difficulty.
- Save money for companies.
Employers like it because it is a way of avoiding having to pay guaranteed income for pension plans and provides an alternative to employees for compensation purposes in recruitment. Allowing companies to save money here can often create benefits for workers in other ways, such as a business and job itself, higher salaries, etc.
However, 401k’s are not without some disadvantages as well. Some of their more common detractors include:
- Limited investment options.
One of the most common complaints of 401ks is a lack of investing options. This is a particularly contentious one because you have some employees who become overwhelmed with too many choices and want a scaled-down option list and others want to be able to put their funds to work in all kinds of different asset classes.
- Higher risk than guaranteed pension plans.
Beyond the concern about the lack of 401k investment options, 401k’s bring a higher level of risk than guaranteed pension plans. Many employees have seen their 401k’s drop significantly in the fall of 2008 showing the riskiness of 401k plans. With reasons like these, there has been a bit of backlash against 401ks although they will likely remain the most popular extra compensation for companies shortly.
With all this said, 401k’s can be a very effective tool in helping people save money toward retirement. However, as with any investment option, you need to give it the due diligence it deserves. The recent drop in many workers’ 401k plan values shows that you cannot and should not implement the strategy of putting your money in a 401k and not following it. Instead, the better advice is to periodically monitor your plan and make adjustments on planned spikes in risk. This will help provide you a greater chance to guard yourself against wide swings in the market even if it does require a little additional work in monitoring your different investment options.