When does it Make Sense to Participate in a 401k Plan

You should always participate in a 401(k) plan, for at least the following four reasons:

1. You will save money right now. Funds taken from your salary in your current paycheck for funding your 401(k) plan will reduce the amount you are taxed from that paycheck. That is, your payroll taxes (federal, state, city, Medicare, etc.) will be reduced, because your salary is smaller.

2. You will save money for your retirement. Chances are good that you have spent time thinking about investing, but have not found the time to invest, or invest as much as you would like, for your future. It is time consuming to open and account, let alone to decide with whom to open the account (a discount broker?, a full service broker? a bank offering brokerage services? which discount broker, full service broker or bank?); you have other more immediate and concrete pressing issues taking your attention; there are many, many other reasons. The money you put into your 401(k) plan is automatic and done without an unreasonable amount of paperwork and transaction costs (of time and effort) on your part. It still may not be as much as you wanted to save, but it is a start. And the brokerage fees and time you need to spend are minimal.

3. The investment choices are more manageable. Chances are your 401(k) plan only has a limited number of relatively conservative investment options, consisting primarily of various categories of mutual funds. Some plans may permit investment in stock directly, but many do not even provide this option. Further, your employer has a duty to periodically review the investment choices and exercise consideration in determining whether the investment choices available are in the best interests of the plan and its participants. Following the investment account-related retirement problems publicized with the collapse of prominent businesses in prior years (e.g., Enron), the obligations of plan sponsors have increased. The diversity and appropriateness of investment options for plan participants are generally of reasonable quality and make participation in a plan more attractive.

4. Many plan sponsors co-invest with you, effectively giving you money for free. It is not uncommon for an employer to match at least part of your investment each time you make a contribution to your 401(k) plan. For example, an employer may contribute a quarter for each dollar you contribute, up to some percentage (e.g., 5%) of each paycheck contribution you make. Failing to participate in such a program is literally walking away from free money. Be aware, however, that it is also not uncommon for the employer contribution to vest over a period of years, so that, for example, if you leave your employer too quickly, you may only keep a portion of the employer’s contribution.