How much hould you invest in 401K? Advantages and Disadvantages
401 K is an excellent investment for a lot of people especially high earning individuals.
You can save 1/3rd of the $18K in taxes assuming you are in 30% tax bracket. You save $6K right away.
If you have an employer match, you will save that additional amount for free.
If recession hits at the time of your retirement, your money is exposed to that market, but its the same even if you invest in index funds anywhere. You need to have a plan in place to adjust the investment plan as you approach retirement age to minimize big fluctuations in your account i.e. by putting more money in bonds rather than stocks near retirement age. Bonds are more stable than stocks in terms of fluctuation during market ups and downs. Also, you should diversify your portfolio and use other funds too at that time like CDs, Money Market Fund, etc.
During recession time, there’s no investment vehicle, not even life insurance, that isn’t exposed in some way to market forces.
At retirement, if there is recession, you will still have 1 or 2 decades to live during which the market will recover. If 401K is the only investment you have, then, it is a bad situation. You will be forced to sell low at that point.
401K benefits from compound interest on the profits each year without paying taxes on profits. This is a great advantage. My suspicion is that tax rates will be much higher in the future.
You will likely have lower income in retirement age, so you may be in one of the lowest tax brackets. You may actually pay less taxes at that time. You have to pay taxes on the money either way. With 401k you defer them till the end and get compounding interest benefit until then without taxes eating into it for 20-40 years or so.
RMDs=Required Minimum Distributions [removal form 401K] start at 70 years of age. It won’t be a problem if you do not have a lot of money in IRA. You can lower RMDs by making withdrawals from 401k to IRA and then doing Roth conversions prior to age 70. You can avoid RMDs altogether if you do ROTH conversions. Ask some experienced individuals about this.
Exposure to the stock market has made millions of long-term investors wealthy. No investment out performs the market over time. Markets have fluctuations and that is the reason, one should learn how to diversify portfolio. Buy different kinds of investments rather than confining yourself to buying just a few types.
Low Cost Total Stock Market index funds have great diversification and are the best investments. VTSAX in vanguard is one such example.
Most people advise putting at least up to employer match in 401K. Some employers pay 5% of salary dollar to dollar match in 401K. If you earn a lot and 5% of your salary is $18K, you instantly doubled your money. You can’t beat that.
The downside to 401Ks and also IRAs is that you cannot access the money prior to turning 59 1/2 of age without paying a penalty.