Three Benefits of Funding Your 401(k)

Maurie Backman, Contributor, The Motley Fool
October 30, 2017

It's official: Come 2018, working Americans will have an even greater opportunity to set aside money for the future. That's because the IRS just announced an increase to the annual contribution limits for 401(k) plans. Though the current annual limit, effective through the end of 2017, is $18,000 for workers under 50, employees starting next year will have the option to contribute an extra $500, for a total of $18,500.

Older workers will also benefit from this increase. Currently, those 50 and over get a $6,000 catch-up provision that raises their annual contribution limit to $24,000. And while the catch-up allowance itself is not increasing, employees 50 and above will get the option to contribute up to $24,500 to their 401(k)s next year.

When you weigh these limits — $18,500 and $24,500 — against the annual limits for IRAs, it's clear that 401(k)s offer a far better savings opportunity contribution-wise. That's because IRAs max out at $5,500 a year for workers under 50, and $6,500 a year for those 50 and over. And those numbers apply to next year as well, because unlike 401(k), IRAs didn't get an increase for 2018.

But contribution limits aside, there are plenty of great reasons to save for retirement in a 401(k). Here are just a few you should know about.

1. Seamless contributions
Though funding an IRA is by no means difficult, it does require you to be proactive. You'll need to contact your financial advisor or institution, send in a check and verify that your funds are received. With a 401(k), on the other hand, all you need to do is sign up with your employer and decide how much money to set aside from each paycheck. Your company will then take care of the rest by deducting that amount pre-tax and sending it directly to your account. And you'll know that money is in there when you view your pay stub and see a deduction for your contribution. It's really that simple.

2. Delayed required minimum distributions
Countless seniors are caught by surprise when they learn that their retirement funds can't sit and grow indefinitely. But unless you have a Roth-style retirement account, you'll be required to start withdrawing from your savings once you reach 70 1/2. Fail to take your required minimum distribution (RMD) for the year in full, and you'll face a penalty equal to 50 percent of the amount you were supposed to withdraw but didn't.

Now, if you're housing your retirement savings in an IRA, you'll get no leeway with regard to RMDs. But if you have money in a 401(k), and you're still working by the time you turn 70 1/2, you'll get a pass on RMDs for the time being. In fact, you won't have to take your first RMD until you stop working for the company whose plan you're participating in (assuming you don't own 5 percent or more of that company). This not only gives your money more time to grow in a tax-advantaged fashion but helps you delay and better plan for the taxes that RMDs are known to trigger.

3. Earlier access to your money
Unless you're saving for retirement in a Roth account, you're barred from accessing your money until you turn 59 1/2. Tap that account sooner, and you'll face a 10 percent early withdrawal penalty on the amount you remove. There is an exception, however, for older workers with 401(k)s. If you have a 401(k) and leave your job the year you turn 55 or later, you'll have the option to take penalty-free withdrawals from that account. Even though taking premature distributions comes with its own share of consequences, this sort of flexibility can be instrumental later in life — especially if you've saved well and want to enjoy an early retirement while you're healthy enough to make the most of it.

Let's be clear: As long as you make an active effort to save for retirement, you're making a wise decision. And there's certainly nothing wrong with saving in an IRA, especially if you don't have access to an employer-sponsored plan. But if you are given the option to sign up for a 401(k), it pays to start participating. Not only will you get a chance to amass a huge nest egg, but you'll reap several benefits that other accounts simply can't offer.

This article was written by Maurie Backman from The Motley Fool and was legally licensed through the NewsCred publisher network. 

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