What’s the buzz about 401(k) plans?
Whether you’re fresh out of college and completely new to the workforce, or simply discovering 401(k) plans for the first time, is saving for retirement a relevant topic of consideration and discussion?
Absolutely.
Preparing for life after the workforce can provide you with financial security in your later years. Retirement savings, such as those held and managed in a 401(k) account, can serve as a monetary cushion, which may help ease future financial burdens upon workplace exit when a salary is no longer a contributing factor to your monthly and annual household income.
Where to start?
A 401(k) is a feature of a qualified – or employer-sponsored – profit-sharing retirement plan that allows employees to contribute a portion of their income to an individual savings account.1
IBKR Podcasts’ Cents of Security, Episode 4, “401Ks Explained”, discusses 401(k) accounts, and why plan consideration and account contribution is essential to the prolongment of your financial security post-career.
Barbara Olander, best says,
“the employee should use that account less so as a savings account from which they can periodically withdraw money, but more as a sort of set it and forget it type of savings place, and only really focus on using that money when they are in their retirement years.”
401(k) plans
The two main 401(k) account plan types are: traditional and Roth.
A traditional 401(k) plan allows eligible employees to make pre-tax elective deferrals through payroll deductions. As a portion of the employee’s pay is deposited into their 401(k) account, the designation could either be a percentage of the employee’s total compensation or a hard dollar amount. This contribution of pre-tax dollars can lower an employee’s taxable income, and in some instances, dependent on the specific plan, an employer may even match the employee’s contribution, in full or in part, on the employee’s behalf.2
On the other hand, a Roth 401(k) – not to be confused with a Roth IRA – is considered a “hybrid” between a traditional 401(k) and an IRA.
Like a traditional 401(k) account plan, a Roth 401(k) is a profit-sharing plan where an employer may also match employee contributions. However, unlike a traditional 401(k), a Roth 401(k) is different in that it’s funded with after-tax dollars. Whereas a traditional 401(k) grows investments tax-free (i.e., with the employee paying taxes on the amount that they have contributed only upon the withdrawal of the funds), a Roth 401(k) does notinclude an income tax break when funded. A Roth 401(k) account plan requires tax to be paid on the contributed dollar amount upfront.
A Roth 401(k)’s comparison to a Roth IRA, furthermore, lies in its similarity of employee post-tax contributions. However, a Roth 401(k) is dissimilar in that a 401(k) is employer-sponsored, whereas an IRA is self-sponsored. Additionally, unlike that of a Roth 401(k), Roth IRA contributions are made through regular payroll deductions and have the same limits as a tax-deferred 401(k) account.
Assessing your options
So, how do you know which is the best retirement plan for you? Is it possible to have both a traditional 401(k) and a Roth 401(k) account plan? Or do you have to choose?
First and foremost, it is *possible to have both a traditional 401(k) and a Roth 401(k) account. However, this is only if your employer offers both types of 401(k) plans, and only if the total contribution to the two types of accounts doesn’t exceed the limit for one account (e.g., $23,000 for those under age 50 in 2024).3
If you do plan to choose, however, there isn’t a right or wrong answer. It all comes down to one’s unique situation and individual preferences.
401(k) contributions
In either considering both or choosing between a traditional 401(k) and a Roth 401(k) account, it is important to take note of each account plan type’s contribution limits.
As previously mentioned, having both types of accounts is possible if the total contribution doesn’t exceed the limit for one account. To clarify, you can’t contribute the present year’s salary deferral limit to each 401(k). Instead, you must divide the total amount between both accounts. The same applies for your total annual contribution, which includes employer matches.
Considering, the contribution limits for *both a traditional 401(k) and Roth 401(k) in 2024 are:
| Under age 50 | Aged 50 and older | |
| Salary deferral: | $23,000 | $69,000 |
| Total contribution: | $30,500 (including $7,500 catch-up contribution) | $76,500 (including $7,500 catch-up contribution) |
(Internal Revenue Service (IRS) 2024)
Closing Thoughts
Contributing to a 401(k), whether traditional or Roth or both, offers several advantages, primarily future financial security in your later years and/or retirement.
Despite also having disadvantages (e.g., early withdrawal penalties, potential investment limitations, and vulnerability to market fluctuations), the benefits often outweigh the disadvantages due to the potential for employer matches, tax advantages, and the power of compounding interest over time.
The amount you should contribute to your 401(k) is specific to your individual goals and preferences. It depends on various factors, including your age, income, and financial plans. There’s no set limit or requirement to have a 401(k), but having an account and plan and contributing up the annual maximum can maximize your benefits for years to come.
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For further learning and understanding of different types of retirement accounts, check out the Traders’ Academy course, “Taxes and Retirement”.
Footnotes
1 Internal Revenue Service (IRS). 2024. 401(k) Plans. January 29. https://www.irs.gov/retirement-plans/401k-plans.
2 —. 2023. 401(k) Plan Overview. August 29. https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview.
3 —. 2023. “2024 Limitations Adjusted as Provided in Section 415(d), etc.” www.irs.gov. https://www.irs.gov/pub/irs-drop/n-23-75.pdf.
4 —. 2024. Retirement topics: 401(k) and profit-sharing plan contribution limits. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.
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