401ks can be good for you

Experts estimate that you’ll need between 60 and 80 percent of your pre-retirement income to live comfortably after you leave the work world behind. Sure, you could open an IRA. But you’ll be able to contribute far more — over three times as much — to your nest egg with a 401k.

Currently, federal laws limit your IRA contributions to just $5,000 per year. With a 401k, you could be contributing as much as $16,500 per year. If you’re 50 or older, you’re allowed to make an annual “catch-up” contribution of $5,500. That’s as much as $22,000 per year you could put towards retirement.

Are you self-employed? Even better. Self-employed owners may be able to contribute up to a whopping $49,000 annually to a 401k!

All that money in your 401k can grow on a tax-deferred basis (or tax-free in the case of a Roth 401k). Don't forget that the earnings are compounding, as well.

See how compounding can really make a difference for you.

^*This example compares how a one-time investment of $1,000 can grow over time assuming an 8.0% fixed annual rate of return. Your account may earn more or less. This is a hypothetical example only, and not a guarantee of future returns. Actual experience will vary with portfolio selections and changing market conditions. The total account balance does not take into account federal and state income taxes, which will be due upon withdrawal. Assets withdrawn before 59½ may incur a 10% tax penalty.

Not only does a 401k allow you and your employees to sock away more money for retirement, it also allows you to shelter those funds from taxes — with the government’s blessing, of course. You have two options:

With a traditional 401k, any contributions you and your company make — plus any gains those funds earn — won’t be taxed until you withdraw them in retirement. Saving on a tax-deferred basis minimizes the impact on your paycheck now.

The Roth 401k works in reverse. You pay taxes on your contributions now, but those funds and any gains earned can be withdrawn tax free at retirement! With a Roth, your paycheck will take a bigger hit today, but you may stand to benefit later.

Either way you go, it’s a win-win tax situation for you (and any employees).

Here’s another benefit you don’t get with an IRA: immediate access to your money when you really need it, with no penalties.

Of course, you don’t want to remove money from your retirement nest egg unless it’s truly necessary. But with a 401k, at least you have the option of doing so. You can loan yourself as much as $50,000 from your 401k savings, and as long as you pay it back as agreed, there are no tax penalties to contend with. Even the interest you pay on the loan goes back into your account.

(Note that if you were to terminate your 401k without repaying the loan in full, there would be tax penalties — typically a 10% surcharge. Employees who choose this option should be careful: if their employment with the company were to end, any outstanding balances on their 401k loan would become due soon thereafter.)

Contrary to popular belief, it’s not a requirement that your company offer employees a matching contribution program with your 401k; it’s an option. But if you decide to do so, you can reap the benefits personally as well. It’s the same story if you decide to offer your employees 401k profit-sharing: you get a cut of the profits too (and a corporate tax deduction).

(Note that owners’ and key employees’ personal contributions may be limited in the absence of a match or Safe Harbor plan.)