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Even unmatched 401(k)s are
worthwhile
Dear Money Matters,
My employer does not match 401(k) contributions.
Do you feel it's worth contributing when this is the case? I've
heard financial planners say no, because the amount of taxes that
need to be paid when the money is withdrawn is offset by the employer's
contribution.
Diane
Dear Diane,
Not to chastise an entire profession, but any financial
planner who suggests that a 401(k) isn't worthwhile just because
there's no employer match should whack themselves upside the head
with their bulky calculators until they rattle more sense into their
brains.
Granted, not having an employer match for your 401(k)
program isn't great news, but there are plenty other compelling
reasons to continue to take part in your 401(k). And, akin to some
planners' rationale that taxes nix 401(k) participation, it's the
numbers that argue in favor of funding your 401(k) to the absolute
max.
Here's how it works: As you probably know, all 401(k)
contributions take place before you receive them as income. That,
in effect, is a generous return unto itself, since you're not paying
taxes on funds that you're putting to work for you immediately.
Add to that any return that your 401(k) plan earns, and the overall
payback increases all the more.
Here's a scenario to amplify what I just tried to
explain. Say you're in the 27 percent tax bracket. Every time you
earmark money from your salary for your 401(k), you're effectively
earning a 27 percent return right off the bat since you're skirting
taxes on that income. Add on any applicable state income taxes and
your return increases all the more -- all with nothing in return
from whatever investment vehicle you've chosen for your 401(k).
Granted, critics of no-match 401(k)s have a point
in that you will have to pay taxes once you start withdrawing your
money. However, that argument overlooks a couple of salient points.
For one thing, your 401(k) will likely grow in value over the course
of many years -- in turn, that will likely more than offset the
tax liability once you start accessing the account. Indeed, the
argument of tax liability seems to me a moot one -- if you're concerned
about paying taxes on profits you've accumulated, why invest at
all?
Another point that's glossed over somewhat is your
tax bracket. One of the central elements of tax-deferred investing
for retirement is that, in theory, once you retire and start pulling
money from retirement accounts, you may well be in a lower tax bracket
than you are now when you're working and earning an income. That
makes a world of sense -- what would you rather do, get socked with
taxes now at a higher rate or stow the money away and take a lighter
hit when your bracket has dropped?
So I would urge you to keep funding your 401(k)
as much as possible. And, for what it's worth, you may try lobbying
your firm's managers to see if you can't win them over to the idea
of some sort of match, however modest. In this era when compensation
in varied forms is critical to hiring and keeping top employees,
an increasing number of companies are coming to realize that a solid
401(k) plan can be just as attractive as a competitive salary and
other benefits.
-- Posted: July 22, 2002
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