401(k) is a retirement plan that can receive contributions from both the employer and the employee. Your contribution is taken from the salary before calculating your taxable income, which is one of the most significant benefits of the plan. Usually, companies match the contribution made by the employee. This is one of the major differences between IRA and 401(k) plans since IRA plans do not usually get employer contributions.
While a 401(k) is a great way to save towards your retirement, you should be aware of some important aspects of the system.
Control over your investments
You will have some control over the plan and would be able to choose from a number of available options like stocks, mutual funds, and bonds. Such plans are known as participant directed 401(k) plans. In the other option, the company’s hired advisor will take care of these details on behalf of all the employees.
Associated costs
Whenever there is third-party intervention, you can expect their fees to figure in your expenses. The same is true for 401(k) plans, where you will have to pay out of pocket expenses to the company managing or administering the plan.
Automatic balancing
If you do not want a large proportion of your funds to be invested in the stock market, you need to opt for automatic rebalancing to diversify your investments. You would need this feature because your investments change in value all the time and it becomes very difficult to manually keep track of the percentage allocation of your funds in stocks. With automatic rebalancing, every time your fund allocations deviate from the limits set by you, the investments are readjusted to bring them back on track.
Don’t invest heavily in company shares
You may be tempted to put a lot of money in stocks of your own company through a 401(k) plan, but you should remember that you can’t take too much risk with your retirement fund, no matter how well your company is doing currently. Take the case of Enron. They filed for bankruptcy and their employees realized that along with losing their jobs, they also lost a great deal of money since their retirement funds were invested heavily in company stock.
It’s true that your employer is required to offer plans with a low risk and at a reasonable cost. But you still need to be proactive in managing your investments and ensuring that you minimize risk. It’s your money after all!