The Pros and Cons of a 401(k) Retirement Plan

By Tom Sedoric and Casey Snyder

In the grand scheme of things, saving for your retirement in any fashion is a smart move. At its fundamental core, a dollar put away to accumulate interest over time is a step in the right direction.

As we know, there is more to it than that. Understanding your long-term goals and establishing what you’re looking to experience in retirement is what will inform how much you ought to be saving and how that investment strategy will look as you work towards life beyond your working years.

Today, let’s talk about one of the most widely known modes of saving: The trusty 401(k). 

It’s interesting to note that of the 79% of Americans who have access to 401(k) plans, only 32% of them are taking advantage of the investment opportunity. That’s a startlingly low number. And it’s telling of how we view savings in our country—especially when studies show that nearly half of all Americans can expect to struggle in retirement from a financial perspective. 

For those that are contributing to their 401(k), there’s a fair percentage of them that are of the mindset that this mode of saving and investment is their sole savior as it’s related to financial success in retirement.

Let’s Set the Record Straight

While we ought to get the numbers of 401(k) retirement plan adopters up, we also need to keep in mind that investing in a 401(k) plan needs to be recognized as a piece of an investment strategy, not the entire investment strategy.

Use it as a tool. And use it to your advantage. In many cases, a 401(k) plan is bolstered by an employer match, which is of further benefit to you to increase your fiscal saturation in the account. It’s like free money, and who doesn’t love free money? Any chance to expand your retirement savings with minimal effort or risk is an invaluable piece to any investment strategy. 

Let’s quickly define the two types that exist: 

• Traditional 
• Roth

These two types of investments are similar because they’re both subject to consistent parameters concerning how much you can contribute to the accounts annually. Where they differ is in the way they work in terms of tax considerations. 

A traditional 401(k) is set up to accept contributions made on pre-tax dollars. Thus, once you start pulling from this account in retirement, you’d be assessed applicable state and federal tax liabilities on those monies as a form of income.

A Roth 401(k) accepts contributions on post-tax dollars. Because you’ve already paid taxes on these monies, you would not be assessed a tax liability on debited resources once you’ve reached applicable access guidelines.
 

What 401(k) Retirement Plan is Best?

The notion of which is better is entirely up to the investor. In general, utilizing the savings power of a 401(k) is a good thing. 

With that said, be smart about your investment strategy. 

In our eyes, the 401(k) market is similar to the credit card industry. There’s a lot of value there if you know how to use it. If you don’t, it’s very easy to get burned. A 401(k) is not your answer to complete financial stability in retirement. 

By thinking that a 401(k) plan is the only solution to your long-term financial security is a short-sighted and misinformed approach. It’s not. It’s a tool to help you create future financial security. That tool needs to be used wisely within your current and future projected tax exposures. The investment strategy needs to be managed with your timeline, risk exposure, and future tax exposure in mind. 
 

Avoid Common 401(k) Retirement Pitfalls

A lot of people think, ‘I’m contributing to my 401(k) plan; therefore I’m on track,’ without viewing it in the context of their: 

• Goals
• Timeline
• Assumed returns
• Tax returns
• ...And more

For most, the default option is the traditional 401(k), which, as we’ve identified, is pre-taxed savings. The trap there is in the thinking that it’s deferred savings with the premise that you’re likely to be in a lower tax bracket in retirement than you are in your working years, making your tax liability lower. This may be true for some of your working years, but probably not for all of them. 

Many of our clients here at The Sedoric Group are in an equal or quite similar tax bracket to the one they were in during their careers. With that said, if tax rates are expected to rise over the coming 10, 20, 30 years, it’s very realistic that you may be in a higher tax bracket than you are during your savings years, making your tax liability higher when it’s time to draw from your 401(k). So, the assumption that “deferral is always the best option” is a very misleading and dangerous proposition. 

• Saving for retirement, in general, is great. 
• The automated aspects of a 401(k) are great (contributions get pulled directly from your payroll).
• The dollar cost average of a 401(k) is great.

The real danger of the 401(k) is when people look at it as their sole asset—their complete retirement solution. 

As people move firms throughout their careers, old 401(k) accounts start being left behind, creating fragmentation within one’s overall strategy and balance sheet. This can reach the point where the investor doesn’t know what one account is doing vs. another account because they don’t view the entirety of these portfolio items as a whole. It’s very easy for investors to wind up with overlapping risks without knowing it. Thus the fragmentation of 401(k) accounts over time can be problematic. 

In some ways, the 401(k) boom can be considered a financial strategy failure because of how it was promoted as the solution to pensions, when in fact, they don’t really compare. Pensions were wonderful. And while 401(k) plans are a positive tool, they require you to use them wisely without always knowing how to use them wisely. This is where the credit card industry analogy comes in. When you’re a kid, you don’t know how to use a credit card. It’s all trial and error. You learn over time that some features and strategies allow you to use a credit card in a positive, financially responsible way. You make it work for you instead of turning into a financial black hole that feels impossible to climb out of. Both can compound interest—though the way that interest compounds can work in opposite ways. 
 

Get in Early, Stay Late

Retirement planning takes years of work, so if you learn how to use a 401(k) responsibly at 40 vs. 24, you’ve lost a lot of time and a lot of value. It’s best to get in as early as possible to get as much value out of it as possible. With that said, it’s never too late to start. In conjunction with a 401(k) investment account, consult the guidance of a financial advisor to understand the ins and outs of your 401(k). A trusted advisor can also aid in helping to figure out how you can best position yourself for a successful retirement by putting other pieces in place to help you accomplish your unique long-term financial goals.

The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.

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