≡ Menu

5 Reasons Why I Love My 401k

{ 42 comments }

5 Reasons Why I Love My 401k

I love my 401k! If your employer offers a 401k plan, don’t hesitate to take advantage of it. Actually, I like the 401k so much that I think it should be the first investment anyone makes.

I started contributing to my 401k in 1996 when I got my first full time job right out of college. At the time, I didn’t want to invest in a retirement fund because I had better plans for those nice fat paychecks.

  • My brothers were still in college and I wanted to help them out.
  • I was driving an old jalopy that could break down at any moment. (In fact, it broke down a few months after I sold it in 1997. Boy, that intern was mad…)
  • I just moved into an apartment and I didn’t have any furniture.
  • Also, retirement was 40 years away, why should a 22 year old guy contribute to his 401k?

Luckily, my dad convinced me to start investing in my 401k. He didn’t really know how the 401k worked, but he knew I had to start investing as soon as possible. I started off slow, but increased my contribution pretty quickly. In a few years, I was hitting the annual 401k contribution limit and I’ve been doing so ever since. Whew, am I glad I listened to my dad that time! Now that I’m a father, I must admit that dad is right sometimes. Thanks Dad, for helping me get started.

Early Retirement

I wasn’t sure if I could continue to contribute to my 401k when I quit my engineering career. I have some income from blogging, but it’s nowhere near my old paychecks. However, Mrs. RB40 is still working so we are pretty comfortable financially. I opened an individual 401k with Vanguard and I was able to continue adding the annual maximum over the last few years. I still love my 401k and I hope to keep contributing for as long as I can. Mrs. RB40 is also maxing out her contribution every year. Our 401k accounts are the foundation of our investments and they are the biggest part of our net worth. Yes, our 401k is worth more than our home.

So why do I love my 401k so much? Here are 5 reasons why I think every investor should max out their 401k contribution.

1. It’s Easy

For most people, the 401k is the easiest way to invest. Nowadays, many employers automatically enroll you and you have to manually opt out of investing. The contribution is taken out of the paycheck before you get it so you won’t miss the money. It’s a lot more painful to send a check off your broker when the money is already in your saving account. The 401k is just really easy for anyone new to investing. All you need to do is pick the investments and you’re ready to start.

The automation aspect of it is really helpful to new undisciplined investors. If I had to send in a check every month to invest, I’m pretty sure I wouldn’t have been consistent when I was 22. If you are new to investing, just put your contribution in the lowest fee index funds and concentrate on increasing your contribution. When you’re starting out, your saving rate matters much more than the performance of your investment. New investors should try to max out the annual 401k annual contribution as soon as possible. Once your 401k is bigger ($100k?), then you can worry about maximizing the return.

2. Company Matching

Most companies match your 401k contribution up to a point. A typical company matches 50% of the 401k contribution for the first 6% of your salary. Every company is different so check your employer’s policy. Intel used to add 5-10% of my salary to my 401k no matter how much I contributed. I had to stay 5 years for it to fully vest, though. Anyway, many companies have some kind of matching plan so don’t miss out on this benefit.

3. Dollar Cost Averaging

When you contribute a portion of every paycheck to your 401k, you are dollar cost averaging. You don’t have to worry about the volatility of the stock market and you just need to keep investing. When the stock is going up, your whole investment is gaining. When the stock market is down, you are getting a discount on your purchases. The important thing to remember is to keep investing through the downturns. Don’t stop contributing to your 401k when the stock market is down because that’s when you get the best deals.

4. Tax Deferred

You don’t have to pay tax on the money you contributed to your 401k right now. This will lower your tax while you’re working. The tax will be deferred until you make withdrawals in retirement. Most people won’t have as much income in retirement so their tax rate should be lower. You should be able to keep more of your money when you invest in a tax deferred account. Of course, if the tax bracket skyrockets, then you might end up paying more. Hopefully, the government won’t shaft retirees like that. Don’t forget to vote!

5. Fees are more transparent now

When I first started investing in my 401k in the 90s, it was very difficult to find out how much I was paying to invest. Typically, you pay the mutual fund’s fee (expense ratio) and the plan administrative fee. Do you know there is an administrative fee to invest in your 401k? Most people aren’t even aware of this.

For example, I invest in VTSMX in my i401k. The expense ratio is 0.17% and Vanguard charges $20 per year (for each fund) to manage the i401k account. That administrative fee is dirt cheap! Many firms charge nearly 1% to manage your 401k. I have about $67,000 in my 401k now so that comes out to be about $134 ($114 + $20.)

Anyway, it’s much easier to find out how much you are paying in administrative fee because of the recent DOL fee disclosure rule. Check your plan disclosure document to see how much you’re paying to invest in your 401k. Meanwhile, you can see an estimate of how much you’ll pay in fees over your working life at Personal Capital.

Personal Capital check your 401k fee

Our annual fees are about 0.15% of our retirement investment. That’s not bad, but we will still pay over $145,000 over the next 25 years. I’m not happy about that, but check this out.

Personal Capital Check your retirement fee

If we had to pay the “benchmark” fee of 0.50%, our total cost to invest would shoot up to nearly half a million dollars. That’s a lot of money lost to fees.

Anyway, fees are a big deal. 0.35% can amount to over $300,000 in 25 years of investing. The fees you pay to invest is one of the few things you can control. Check how much fees you are paying and try to minimize them as much as possible.

You can try the retirement fee analyzer and other great tools at Personal Capital for free. Check them out if you don’t already have an account.

I Love My 401k!

So that’s why I love my 401k. It’s a great way to build your core investment and you don’t even have to know much about investing. The 401k is the perfect investment for new investors. Some people recommend the following sequence, but I don’t really like it for beginners:

  1. Contribute to 401k up to employer matching
  2. Contribute to Roth IRA
  3. Back to 401k until you reach the annual contribution limit

There are just more chances to screw up. A beginner could forget to contribute to her/his Roth IRA or just stop contributing altogether. There is also a bit too much freedom with a Roth IRA. I invested my Roth IRA in high risk tech stocks when I was in my 20s and lost a bunch of money during the dot com bubble. I would have been better off if I just invested my Roth IRA in low cost index funds like I did with my 401k.

In conclusion, I recommend investing in low cost index funds in your 401k, maxing it out as soon as possible, and keep investing through the down markets. If you do this, you will love your 401k, too.

Do you love your 401k (or equivalent)? If you don’t, tell us why not?

{ 42 comments… add one }
  • Ernie Zelinski August 19, 2015, 1:04 am

    “Do you love your 401k (or equivalent)?”

    Being Canadian, I don’t have a 401K. Here in Canada, however, we have something equivalent called RRSPs (Registered Retirement Savings Plans).

    I liked RRSPs for years and always maxed out my contributions. But I now question whether I should put money in them. Here is the problem. In Alberta where I live, the provincial tax was a flat 10 percent for years. With a socialist government (the NDP) having won the last provincial election, they have just raised the provincial tax rate for the highest bracket to 15 percent. At the same time, the maximum Federal government tax rate was 29 percent. So at the highest tax bracket, one could get a tax break of 39 percent (10 plus 29) for the money one put in RRSP’s.

    But we have a Federal election in October as well. The Liberal party says it will raise the top tax bracket from 29 percent to 33 percent if it wins the election. The NDP (a socialist party) will likely do the same, maybe make it even worse.

    So here is the problem: I got a tax break of 39 percent when I put money in RRSP’s last year. But after the Federal election in October, the total tax in the highest bracket may be 48 percent (15 percent provincial and 33 percent federal). So when I am forced to cash out money from my RRSPs in a few years, I may be subject to a 48 percent tax rate if I am still making a great income from my intellectual property. Who would have known two or three years ago that I could be subject to incredibly high tax rates due to socialist governments provincially and federally?

    To put socialism in proper perspective, here are quips I couldn’t resist sharing:

    “The problem with socialism is that you eventually run out of other peoples’ money.”
    — Margaret Thatcher

    “As with the Christian religion, the worst advertisement for Socialism is its adherents.”
    — George Orwell

    “Socialism in general has a record of failure so blatant that only an intellectual could ignore or evade it.”
    — Thomas Sowell

    “The function of socialism is to raise suffering to a higher level.”
    — Norman Mailer

    Q: What’s the difference between Socialists and potholes?
    A: Libertarians don’t usually run over the same potholes more than once.

    Q: What did the Soviet Socialists use before they got candles?
    A: Electricity.

    • Dividend Growth Investor August 19, 2015, 7:14 am

      What if you move to another province? Or what if you move to live overseas – would that affect the taxation?

      • Ernie Zelinski August 20, 2015, 12:54 am

        Yes, I have considered moving to B.C. For years Alberta had the lowest provincial tax rates in all of Canada. With the latest increases in Alberta, the highest tax brackets in Alberta and B.C. will fairly close. This won’t help me much when I cash out my RRSPs unless BC lowers their tax rates.

    • retirebyforty August 19, 2015, 8:14 am

      You are making a great income so that really push you up the tax bracket. Maybe it’s time to hire a tax accountant to figure out a way to minimize tax? What if you become an expat? 🙂 Great quotes about socialism.

    • ravi August 19, 2015, 5:31 pm

      If you still earn enough each year to be in the top bracket… count your blessings!

      I dislike taxes just like the next person, but I’d love to have a tax problem over an income problem..

      • Ernie Zelinski August 20, 2015, 12:50 am

        Ravi:

        I agree with you. I am just saying that the RRSP’s didn’t turn out as good as I thought they would.

  • Peter August 19, 2015, 1:20 am

    Yep, I think a 401k is great as well! Two main reasons are being taxed deferred and company match. Being tax deferred is a great benefit and to supercharge to early FI. I’ll also say that if anyone can, contribute to a traditional IRA over a Roth IRA because being tax deferred, you are having more money work for you NOW, rather than later. Roth IRA money is already taxed and gone to Uncle Sam forever and ever.

    • retirebyforty August 19, 2015, 8:15 am

      I like Roth IRA too, but I never got over messing it up early in my 20s. So I don’t really love it as much as my 401k.

    • steve August 19, 2015, 11:38 am

      So, I would not necessarily agree with the advice of always contributing to a traditional IRA over a Roth IRA. For example, I have two kids who are both just graduated from college and are beginning their careers. They are both likely to be in the lowest income tax brackets of their adult working lives, and in my mind it makes far more sense to pay the relatively low taxes now, and be able to invest, grow and withdraw that money down the road tax free when they will much likely be in a higher tax rate–even when they are in retirement. As a general matter, I tend to think that tax rates are far more likely to go up than down over time given the fiscal situation in the US, so even if you are in a higher tax bracket now, it may make more sense to pay taxes now before they go up even more. However, as future tax rates are not a certainty, I think a prudent course of action is (at least for people currently in higher tax brackets) is to diversify their investment vehicles—so just like you don’t put all your money in one stock, don;t put all your money in a Roth IRA or a Traditional IRA; put some in a traditional and some in a Roth.

      • Peter August 19, 2015, 3:24 pm

        Hi Steve! Great comment and you make some great points. Diversifying your investment vehicles is definitely a great idea since we don’t know what the future tax brackets/rates will be. I guess I’m just one to work with the current tax environment and learn how to optimize it best. If things were to change, then I’ll change my strategy.

        I understand the the pros of a Roth IRA, however, you cannot touch the Roth IRA funds until 59.5 (except for withdrawing the principal) but with a traditional IRA, you can easily access funds either the 72t rule or doing a Roth IRA ladder conversion in your early FI years (since in your early FI years you’ll be living off of dividends and capital gains), in which you should be in a low tax bracket and the tax burden shouldn’t be that high.

      • retirebyforty August 20, 2015, 8:58 am

        Thanks for your comment. Tax diversification is a good thing. If your kids are discipline, then it’s a good idea. I would advise my kid to just max out his 401k first, though. IMO, I think it’s better to keep it simple when they are starting out. Most kid wouldn’t know how to deal with their Roth IRA.

  • Dave August 19, 2015, 4:56 am

    I love my 401k too. Unfortunately, I didn’t even have one until I was 29. I missed out on a couple years of contributions and I really regret that. I’m trying to make up for it by maxing out my employer’s 401k and contributing the maximum allowed to my solo 401k.

    • retirebyforty August 19, 2015, 8:16 am

      Sorry to hear that. You’re giving it a big boost by contributing to the solo 401k. Hopefully that will make up for the earlier years. Good luck!

  • Justin @ Root of Good August 19, 2015, 4:59 am

    I love our 401ks too! The tax savings gave us a head start on saving our million+ portfolio every year. We’ve both been blessed with generally low fees and access to index funds at the 3 different places we’ve worked (including Institutional Plus Vanguard funds with fees around 0.02% at Mrs. RoG’s current 401k!).

    And the automation of taking the $$ out of the paycheck before we even see it is like magic. The paycheck shrinks, you get used to it. You get by on less while saving tons of money in the background without the pain of sticking $1500 into an investment account each month.

    • retirebyforty August 19, 2015, 8:17 am

      0.02% is really great. Sometime I dread paying all those taxes. I’ll hire a tax accountant when it’s time to withdraw. Automation is a great way to save for young people. Disciplined investors can invest when they want, but it’s really hard to invest consistently when you’re starting out.

  • DP @ Someday Extraordinary August 19, 2015, 5:54 am

    I’m constantly on the fence on this issue and will admit I lose sleep over it. Doesn’t it tear you up that you could potentially spend hundreds of thousands of your future dollars on fees? It’s counterintuitive to the “save as much as you can” mantra.

    The pretax investment capability of 401k’s is unquestionably a huge advantage, but you run into the same tired argument of what taxes could be like when we are able to draw from the 401k. It’s hard to imagine that won’t increase in the next few decades.

    jlcollinsnh blog has a great write up on 401k’s in the “Stock Series” section and some of the comments are invaluable. If you haven’t read it, I highly recommend it!

    -DP

    • retirebyforty August 19, 2015, 8:19 am

      I wouldn’t lose sleep over it. Minimize the fee as much as you can and then live with it. The other option is to invest in individual stocks, but that’s a lot more risky and you still have transaction fees.
      I’ll check out J Collins’ article. Thanks

  • Christa August 19, 2015, 6:04 am

    I always contributed to my 401k but the value of those tax deferred dollars didn’t sink in until I became self employed. I have a SEP IRA now that I contribute to quarterly. Either the money goes in there or it would go to the government. Simple decision where to put that money !

    • retirebyforty August 19, 2015, 8:20 am

      Yeap, it’s pretty incredible how the power of compounding works. Sometime I can’t believe I have that much in my retirement account.

  • SavvyFinancialLatina August 19, 2015, 6:34 am

    This is the best advice I took from you when I started my job 3 years, 3 months ago. I didn’t start maxing it out immediately, even though I wish I had. So to those who are thinking about not maxing it out, just do it. Learn to live by with less. I started maxing out my 401K probably 6 months after starting my job and it has really added up. I have $75K socked away already. Can’t wait to hit the $100K mark.
    I try to defer as many taxes as much as possible. That is what the rich do. Then they hire tax lawyers and CPAs who help them defer taxes even more in the future. Remember, the 1% owns 90% plus of the wealth in the USA. How do you think they do that?

    • retirebyforty August 19, 2015, 8:21 am

      Wow, that’s great! Thanks for letting me know. $75k is awesome for just 3 years. Great job so far and keep at it!

  • Steve Miller August 19, 2015, 6:41 am

    I like the 401k as well, but what do I like better? Roth IRA!

    Why? Because once you retire, you will be in a lower tax bracket (you will be living off dividends and capital gains).

    If you retire early, convert that 401k to a Roth IRA and pay taxes on it when you are in a low tax bracket. Then you never pay any additional taxes on the Roth — let that sucker grow in value tax free!

    • retirebyforty August 19, 2015, 8:21 am

      I like the Roth IRA too. I just wish I was a bit more savvy when I first started. I’m going to build a Roth IRA ladder when Mrs. RB40 quit her job.

  • Dividend Growth Investor August 19, 2015, 7:12 am

    Hi Joe,

    Why do you invest in VTSMX, when you could purchase the lower cost VTSAX or the ETF VTI? Are those options not available at Vanguard’s i401k?

    VTSAX and VTI have a cost of 0.05% vs 0.17% for VTSMX

    • retirebyforty August 19, 2015, 8:22 am

      You can only invest in investor class mutual funds at Vanguard’s i401k. I should check with Fidelity. I like Vanguard, though.

  • Ali @ Anything You Want August 19, 2015, 9:34 am

    I love the easy dollar-cost-averaging that 401k and equivalents allow. Unfortunately, at my company, there is no matching, which kind of stinks. Otherwise that is another huge perk for me – free money!

    • retirebyforty August 20, 2015, 8:49 am

      Sorry to hear that. Companies should match. It’s a good incentive for employee to save.

  • Austin August 19, 2015, 9:55 am

    “Do you love your 401k (or equivalent)? If you don’t, tell us why not?”

    I love the idea of a 401k. I just don’t like my 401k plan, as is. Here is why:

    1. Participation. My company has a 1 year waiting period requirement with 2 enrollment dates per year. I was hired right after an enrollment date which essentially makes me have to wait 18 months to enroll. January can’t come fast enough!
    2. Investment options. Just terrible funds. Merely a selection of about 12 actively managed funds, many looked small-mid cap growth focused. No broad index funds or no target date funds available.
    3. High fees. The expense ratios on most of the funds are higher than industry average and range from 1%-1.3%. International funds are more. The plan administrative fee is $40 a year, which isn’t bad but the Plan Advisor has talked about eliminating this.
    4. No Roth. Having the Roth option for your 401k contributions used to be more of a luxury, but some of the latest reports say that more than 50% of employers currently offer the Roth 401k. Obviously it wasn’t a deal breaker when I took the job but my disappointment comes from the CFO and Plan Advisor having openly talked several times about being able to create the Roth option but just “haven’t got around to it yet”.

    I don’t like my 401k but its the only one I’ve got. I plan to follow up with the CFO and Plan Advisor 2 months before the next enrollment date, hopefully the plan will be improved. One nice perk of my plan is the employers’ match is always fully vested. I plan to use the 3 step method with maxing out a Roth IRA in step 2 before I really put more than 5-7% and eventually the max contributions in my 401k.

    • retirebyforty August 20, 2015, 8:52 am

      Oh wow, that’s not a very good plan. 18 months to enroll is pretty bad.
      I wonder why companies stay with these bad plans? It shouldn’t be that much more expensive to go with Vanguard. Actually, I don’t know the fee structure of big company plans. Hopefully they’ll improve it at some point. A good 401k is a great incentive for employees. Going with the 3 steps is a great option for you.

  • Al August 19, 2015, 11:18 am

    Hi Joe – What are your thoughts about ROTH 401k contributions?

    I have been maxing out my 401k with pre-tax dollars in the past year, but decided to do Roth 401k this year.

    I am not sure of tax rates in the future and also I know my income will be lower in the future but could be still in a higher tax bracket with rental income (which i know is part of your retirement portfolio too).

    -Al

    • retirebyforty August 20, 2015, 8:54 am

      I like the Roth 401k too. I contributed for a few years. Overall, you can save more. However, I reverted back to traditional 401k to get the tax deduction on my last year at work. You could contribute to both to diversify.
      If you’re in the top bracket, you probably should go with the traditional 401k to get the tax deduction.

      • Al August 28, 2015, 6:25 am

        Ok. ill take that into consideration and may switch back to traditional 401k next year. i am in a high tax bracket now and i dont see it really coming down that much during retirement as I have 1 rental property now and 1 primary. I plan to purchase atleast 1 more rental property before i retire (long term plan).

        I am thinking that income from 2 rental properties + 401k RMD + IRA RMD + social security may keep me in higher tax bracket during retirement. Have you taken this into consideration ?

        • retirebyforty August 28, 2015, 9:37 am

          You probably should hire a tax specialist to help you minimize tax. You can probably roll some IRA over to Roth before social security kicks in. I’m sure there are other tricks to help reduce tax. Maybe retire early and take the rule 72t withdrawal.

  • Emily @ evolvingPF August 19, 2015, 11:29 am

    My husband just got his First Real Job this month and now has access to a 401(k) for the first time! Unfortunately, he is not enrolled yet – this is definitely partially due to the company’s accountant being slow but he could probably be pushing harder to get the paperwork through. I’m excited for him to start contributing for all the reasons you mentioned (save that there is no match) – especially now that the fees are more transparent.

    I guess I should really say I love my Roth IRA though – having been in a low tax bracket for all these years. But I’m excited for the higher contribution limits the 401(k) offers.

    • retirebyforty August 20, 2015, 8:55 am

      Congratulation to your husband! Sorry that he doesn’t get a match. That’s too bad.
      Roth IRA is great too. 🙂

  • Leigh August 19, 2015, 5:57 pm

    I love my 401(k) too! I love how much it saves me in taxes and how much I can contribute to it. Mine allows after-tax contributions in addition to pre-tax/Roth, has a good match, and has great funds to choose from. 2015 is the 5th year now that I’ve maxed out my 401(k) and I have about $110,000 in my pre-tax 401(k). I’m now maxing out the after-tax contributions so long as I can, which will add to my healthy Roth IRA balance. I’m 27 and from maxing out almost all of my retirement accounts for as long as I could (I missed one year of Roth IRA contributions, so $5,000, and didn’t max out my 401(k) the first year working, missing $14,000 in pre-tax contributions), so I have about $200k in retirement accounts now. It’s really fun watching the account start to compound all on its own now!

    • retirebyforty August 20, 2015, 9:00 am

      That’s great! I didn’t have the after-tax option when I was working. That’s a great way to boost your saving. $200k is really great at your age. Good luck on your journey.

  • Mrs. Budgets @MrandMrsBudgets August 20, 2015, 6:14 am

    We max out our 401Ks too. I don’t dollar cost average though, I front load our 401K’s. I read a post about it on madFIentist and I am happy I’ve done it so far. You can check out his post (http://madfientist.com/front-loading/) for those who want to maximize their returns on their 401K’s.

    • retirebyforty August 20, 2015, 9:02 am

      I tried front loading for a year. It was okay. I don’t think it made a huge difference. I guess over 40 years, it would add up. It’s probably too difficult for most people to do.

  • Bryan @ Just One More Year August 20, 2015, 10:00 am

    I love my 401k and IRAs!

    Reason number 6: I have a mindset that I cannot touch this money for decades. No thoughts should enter your mind about taking money out after leaving an employer (rollover) or asking for a loan! This creates the magic of compounding. The earlier you start, the better the long-term results.

  • Duncan August 20, 2015, 10:29 am

    I like my 401k, but I think it’s a limited part of my fiscal freedom. Contributing to it is important, don’t get me wrong, but it’s freedom is 30 years from now for me. I don’t mind paying a couple of bucks now, especially since I consider the current financial situation of the US perilous to taxes in a couple decades if we can’t get our financial shop in order.

  • EL August 20, 2015, 10:43 am

    I don’t know why anyone wouldn’t invest in a 401K. ITs so simple and effective and you get free money. If your bills are more than income, cut costs. If your debt is overwhelming, at least try to do up to the match. Ive always invested in my 401K.

Leave a Comment