With the 401(k) match at some companies disappearing in the wake of COVID-19, is it time to look into other types of retirement accounts?
As uncertainty surrounding the long-term financial fallout from the COVID-19 pandemic weighs on businesses and recession fears continue, the 401(k) employer match could be in danger. Some large companies have suspended their 401(k) matching programs, potentially impacting tens of thousands of retirement savers.
What could this mean for your retirement plan? Might this be a good time to use other types of retirement accounts to attempt to make up the difference?
Alicia H. Munnell, director of the Center for Retirement Research at Boston College, pointed out in a MarketWatch column that there’s generally a positive relationship between employee retirement savings and 401(k) matching programs. When there’s a 401(k) company match—perhaps the closest thing to a free lunch in the retirement savings world—employees are more likely to set money aside for retirement. They may even raise their contribution levels in order to get the maximum match.
What is a 401(k) employer match? If your employer offers a 50% match on up to 6% of your income, for example, you’ll receive an extra 50 cents for each dollar you contribute, up to the income threshold. So if you make $4,000 each paycheck, and you contribute 6% of your income to your 401(k), that’s $240 from you. With the 401(k) company match, you get another $120 added to your account. And those employer contributions don’t count toward the $19,500 contribution maximum (plus catch-up contributions if you’re over 50).
Another bonus? Your employer’s matching contribution doesn’t impact your ability to max out your own contributions. As long as total employee plus employer contributions don’t exceed $57,000 for 2020, you can keep contributing to your 401(k).
Taxes are deferred with a traditional 401(k), and you get the advantage of potential compounding returns over time. Note, however, that if your employer makes a contribution and you have a Roth 401(k), the employer match portion will go into a traditional 401(k).
Regardless of which account type you contribute to, when you consider that you could receive that extra employer boost consistently over a couple of decades, the impact on your nest egg could be significant.
According to Munnell, if the pandemic prolongs the recession, there could be a permanent loss of the 401(k) employer match—leading to a reduction in overall plan participation. But for some retirement savers, the loss of the match—one of the top benefits of many 401(k) plans—could make other types of retirement plans worth a look.
Some retirement savers only put money into their company retirement plan because of a 401(k) matching program. But depending on the employer and the plan administrator, using a 401(k) might not be all it’s cracked up to be. Some of the downsides to a company-sponsored plan might include:
Carefully consider your choices and what might work best for your situation. If you’re mostly participating in your company’s plan because of the 401(k) company match, you might be able to move forward with other types of retirement accounts.
If you decide it makes sense for you, it can be a good idea to open another tax-advantaged plan, such as an Individual Retirement Account (IRA), for at least some of your contributions. Depending on the custodian you use, you might get access to:
Although it’s possible to use an IRA as an alternative to your company’s 401(k), it’s important to note that a traditional or Roth IRA comes with lower contribution limits. With a 401(k), you can add up to $19,500 to your 401(k) with a $6,000 catch-up contribution if you’re at least 50. The IRA limit, on the other hand, is only $6,000 for 2020, with a $1,000 catch-up contribution for those aged 50 and older.
Additionally, the unique benefits of a Roth IRA are available only if you meet the income criteria. Not everyone is eligible to contribute to a Roth IRA. You can convert your 401(k) to a so-called backdoor Roth IRA, but then you become subject to a potential tax bill, as well as other restrictions.
The good news is that you don’t need to choose one or the other. It’s possible to build a retirement strategy around multiple types of retirement accounts.
Some savers who are still receiving an employer 401(k) match may contribute enough to max out the matching program and then direct other money toward an IRA. Once the IRA is maxed out, they could then switch back to investing in the 401(k) to take advantage of the higher contribution limits.
Those who aren’t happy with their 401(k) investment choices—and who don’t have access to a 401(k) matching program—can max out an IRA before contributing to a company plan.
Savers who own businesses or have side gigs may also benefit by using SEP IRAs and solo 401(k) accounts as part of a tax-advantaged saving strategy. It’s even possible to include a health savings account (HSA) in your long-term retirement investing strategy.
However, before deciding to write off the 401(k) just because you don’t get an employer match, it’s important to remember some of the other benefits that can come with your 401(k):
It can make sense in some cases to contribute to both a 401(k) and an IRA, or even use other accounts. Be aware, though, that the tax benefits and consequences may differ, depending on your situation.
Before deciding how to divide your retirement contributions, though, it might make sense to speak with a retirement specialist to review your choices, analyze your account fees, and figure out a strategy most likely to benefit you in the long run.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
Maximum contribution limits cannot be exceeded. Contribution limits provided are based on federal law as stated in the Internal Revenue Code. Applicable state law may be different. TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your IRA.
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