What is best depends on you
Sep 04 '00
When I first became eligible for the 401K where I worked a few years ago I thought it was a great idea. As time went on, I wasn't so sure.
The main things I liked about the idea of having a 401K
First, the money is taken from your check before taxes. This means that you are not required to pay taxes on the money until you withdraw it from your account. Many people will be in a lower tax bracket by this time, assuming that they will not be withdrawing before retirement.
Additionally, since the money is automatically deducted from your paycheck and deposited directly into your 401K account, you will really not miss the money since you never had it to begin with. This can be a relatively painless way to save money for your retirement.
If you take 10% of your check and deposit it into a savings account instead, you will actually have less to show for it since you will have already paid taxes on the check, making the total less. The 10% of the pretax amount adds up much faster than the 10% of the after tax amount.
Though most employees are not eligible to participate in their 401K until they have been employed for at least 1 year, the employer generally matches all or at least a portion of your contribution. My employer matched 100% my contributions, though their share of the contribution is not entirely vested until you have been employed for a given length of time.
For those who don't understand vesting, this simply means that the contributions are made by your employer, but only a certain percentage actually belongs to you as determined by your length of employment. The longer you stay with this company, the higher the percentage is.
What I didn't like about the 401K
A 401K is meant to save for retirement, therefore, if for any reason you need the money sooner, you are out of luck. Although I was told that it was possible to take out a loan against your 401K, I was not able to do so when an emergency arose. I tried to withdraw a portion of my 401K from my account and was told that I could not withdraw the money as long as I was working for that company. Even if I were to quit my job and withdraw the money, I would lose over 1/2 of the money in my 401K by the time I paid all of the penalties for early withdrawals.
Also, in my particular case, I'm not certain that I actually saved any money by going this route. Not only do I have money in an account that I cannot touch, but as a single head of household, I actually get back more money in taxes than I pay in. Pretax amount means very little to me because the taxes paid in all come back to me anyway. What happens if instead of the lower tax bracket most people are in when they retire, I am actually in a higher tax bracket? This is altogether possible in my situation because right now, I have children and am eligible for the Earned Income Credit. When I retire, my children will be grown and I will no longer be eligible for this credit.
Which is better for you?
Basically, it depends on your current circumstances. A 401K is probably a good idea for many people, but not for everyone. If you are in similar circumstances to mine, don't bother with a 401K. I can tell you from my experiences that it will only cause you grief. I may have earned some money from employer contributions, but I will lose all of this and more if I try to use any of this money.
If you are certain that you will not need to use any of this money until retirement, and you are in a higher tax bracket, it is probably a wise investment for you. If the above does not describe your circumstances, you would be much better off with a savings account, or better yet, with CDs.
A savings account does not pay very high interest, but at least you can access your money in case of emergency. My choice was to purchase several CDs, staggering the maturity date. This is a rather simple way to insure that you will always have emergency funds available if needed.
I started small. I bought a new CD each month for a year. The original CDs I bought were 3 month CDs because at the time I could not afford to tie up any amount of money for an extended period of time. Next I advanced to 6 month CDs at a slightly higher interest rate. Once my CDs began to mature, I began to purchase 1 year CDs. Every month I would invest a small amount of money and buy a new CD until I had one which would mature each month of the year.
I started with $5 CDs then advanced to $10 when the first ones matured. Each month I add in an additional amount to my new CD, based on the amount I know I can afford. If I know my $50 CD will be maturing next month, I know I can spare at least that much. If all else fails, I will simply renew the CD for the same amount. If at all possible, I will add to it. Sometimes the additional amount is only $5, but if I can add a bit more, it can really add up quickly.
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