Q. Why should I maximize 401K contribution?
A. It's Okay to ask this question as there are many disadvantages of investing in 401K:
1. There is RMD requirement for 401K
2. You will pay income tax on the gain in the end
3. Your 401K fund choices are very limited
4. All available 401K funds have high expenses
5. It's not flexible, especially when you need money
Given these many disadvantages, you might wonder - why not simply investing in a low cost index fund and buy-and-hold till the retirement time? In the end, you will pay only long-term capital gain which probably will be lower than your ordinary income tax rate at your retirement time, especially you will probably have high retirement income.
However, there is a major advantage of 401K that no other investment options have: you pay no income tax upfront, and to a lesser extent another benefit - your investment gains have no tax until at time of distribution (if you buy-and-hold outside 401K, you also pay no tax, except dividend gains that your funds distribute which is outside of your control).
You can use the following calculator to evaluate whether investing in 401K or not, just plug in your own numbers into the areas highlighted in yellow. The chart shows the end of period after-tax balance under the two options.
A. It's Okay to ask this question as there are many disadvantages of investing in 401K:
1. There is RMD requirement for 401K
2. You will pay income tax on the gain in the end
3. Your 401K fund choices are very limited
4. All available 401K funds have high expenses
5. It's not flexible, especially when you need money
Given these many disadvantages, you might wonder - why not simply investing in a low cost index fund and buy-and-hold till the retirement time? In the end, you will pay only long-term capital gain which probably will be lower than your ordinary income tax rate at your retirement time, especially you will probably have high retirement income.
However, there is a major advantage of 401K that no other investment options have: you pay no income tax upfront, and to a lesser extent another benefit - your investment gains have no tax until at time of distribution (if you buy-and-hold outside 401K, you also pay no tax, except dividend gains that your funds distribute which is outside of your control).
You can use the following calculator to evaluate whether investing in 401K or not, just plug in your own numbers into the areas highlighted in yellow. The chart shows the end of period after-tax balance under the two options.
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