With a variety of retirement options available, lots of people choose to invest their savings in a 401(k). And there are plenty of 401(k) myths that have surfaced in recent times as a direct result. We’ll debunk a few of the most common ones to help make more sense of it all.
If you work full-time, most employers will offer you the option to have a portion of your check deducted and added to a 401(k) savings plan, according to Investopedia.com. It’s a wonderful way to save money for retirement. Before you make your decision on whether or not this is the right route for you to travel, we’ll debunk some prevalent 401(k) myths so you can be in the know moving forwards.
You’ll Save On Your Tax Returns
A lot of people mistakenly believe that they will save on their tax returns because they’ve contributed funds to their 401(k). This is misconstrued. Yes, you will not have to pay income tax on the funds that you set aside for that current tax year. However, when you do cash out the 401(k), income tax fully applies. You may find that you owe more or less tax on the monies you’ve earned and saved, too, dependent upon your income bracket at retirement.
You Can Do Anything You Want with Your Money
Another 401(k) myth that should be put to rest is that you have full control over what you can do with your funds even while they are invested. But most providers charge an early withdrawal fee plus the federal government mandates that a certain portion of the funds are automatically withheld for taxation if you withdraw them early. Sure, you can take out a low-interest loan that is repaid out of your check against the funds in most cases, but cashing it out early can result in a large percentage of it going away right away to taxes and penalties.
Your Heirs Won’t Have to Pay Taxes
A common 401(k) myth is that you can leave your funds to your heirs and they won’t have to pay any income tax on the funds because you left it to them. But that’s not the truth at all. Estate taxes, income taxes and state taxes would still apply. This could eat up as much as 40% or more. Don’t confuse a 401(k) with proper estate planning, ever.
It’s a Better Place to Borrow Funds From
The last 401(k) myth that we will cover is this one. Yes, you can take out loans from your 401(k), but they are repaid out of your paycheck in addition to any preset withholding. What’s more, you have to pay back said loans with interest, and sometimes private loans may be more lucrative. Furthermore, you could miss out on growth opportunities and could also be hit with double taxation on the interest payments that you make.