Why I Love 401ks

This piece on 401ks has a few lines that remind us all why they are such a great deal -- even when the market is declining like it has recently. Check this out:

Most 401(k)s shower free money on participants in two ways. First is the employer match. Second is the tax deduction. If you contribute $200 and the boss chips in 50%, that's a free $100. And your $200 costs you only $150 out of pocket, if you're in the 25% tax bracket, because you'd otherwise pay $50 in income tax. So you are up $300 on $150, a 100% gain, before you even get started. Think about it that way, and the next time somebody asks how your portfolio is doing, you'll be able to modestly, and honestly, reply, "Oh, I'm ahead."

In other words, you have a big, big gain simply by getting the employer match. So even if the market drops a ton (which it has lately), you're still ahead overall.

I've contributed the maximum to my 401k for years now and plan on doing the same for the foreseeable future. There's just something about free money that I can't pass up. ;-)

Comments

[headknocker]

I also contribute to my 401K to get the employer match, but that is all. The rest I am putting in a Roth IRA where I not only have more selections but the growth is tax free. Yes I am "losing" the tax portion because the Roth IRA is after tax money, but all of the growth is tax free. In 20 years when I am ready to retire, having both the 401K and the Roth IRA is going to be sweet.

[WiseMoneyMatters]

That's a great way to look at it. I've never even thought about it that way.

[Todd]

Might be better to say "tax deferral" rather than "tax deduction". You still have to pay that tax in the end.

I agree, the free money from company match is a must.

[Barack]

Are you sure you don't want the government plan that gives you the $600 match and lets you buy government bonds paying 3%?

[Jim]

Employer matches are simply too good of a benefit to not take advantage of. Think of it as a 100% return on an investment.

[rxjohnk]

I think the employer match and the 401k are interesting methods for the government to encourage people to save for retirement. However, I think the tax savings are pretty insignificant to the whole scheme.

If I am 30 years old and max out my retirement and manage to return 9% per year with a 3% match on a $100,000 salary with a 2% annual raise (which ends up being about $200k at age 65/retirement), and I end up with about $5 million in my 401k. Over this period of time I save $160,000 in taxes (25% tax bracket).

So I quit my job at age 65 and take out $200k year. I pay $50,000 in taxes!!! So in just over 3 years, I pay as much as I saved over the course of 35 years...

Pay the taxes today and spend the money tax free at retirement! If your employer doesn't have a Roth 401k option, ask them to start it NOW!

[Anom]

@ Barack (who blasted a 3% growth (which I think was inflation protected) & rxjohnk (who stated an assumption of 9% growth in stocks)

"So where do some reasonable assumptions lead us? Let's say that GDP grows at an average 5% a year--3% real growth, which is pretty darn good, plus 2% inflation. If GDP grows at 5%, and you don't have some help from interest rates, the aggregate value of equities is not going to grow a whole lot more. Yes, you can add on a bit of return from dividends. But with stocks selling where they are today, the importance of dividends to total return is way down from what it used to be. Nor can investors expect to score because companies are busy boosting their per-share earnings by buying in their stock. The offset here is that the companies are just about as busy issuing new stock, both through primary offerings and those ever present stock options.

So I come back to my postulation of 5% growth in GDP and remind you that it is a limiting factor in the returns you're going to get: You cannot expect to forever realize a 12% annual increase--much less 22%--in the valuation of American business if its profitability is growing only at 5%. The inescapable fact is that the value of an asset, whatever its character, cannot over the long term grow faster than its earnings do.

Now, maybe you'd like to argue a different case. Fair enough. But give me your assumptions. If you think the American public is going to make 12% a year in stocks, I think you have to say, for example, "Well, that's because I expect GDP to grow at 10% a year, dividends to add two percentage points to returns, and interest rates to stay at a constant level." Or you've got to rearrange these key variables in some other manner. The Tinker Bell approach--clap if you believe--just won't cut it."

[rxjohnk]

@anom-

The problem isn't in my numbers. It is in your assumptions of my numbers.

Don't buy the whole market! Just buy the good parts! I don't expect the whole market to go up by even 5% per year. I do expect to beat the market however.

The American public will never do as well as the market average even, for many reasons, the most important being because they are human and make decisions based on emotions (eg - "I lost 50 percent on this stock, I'm out").

So, here are my "assumptions": I think that I am going to do better than the average investor because I am willing to invest the time and resources to find good companies to invest in rather than accepting a meager "average" gain and then giving some of that to a mutual fund manager.

I further assume that "anom" is clueless when it comes to investing and economics in general based on this comment alone: "Well, that's because I expect GDP to grow at 10% a year, dividends to add two percentage points to returns, and interest rates to stay at a constant level." There are about 5 other clues in that post that provide further evidence.

Some advice: "It is better to keep your mouth closed and let people think you are a fool than to open it and remove all doubt."