Should You Contribute to a 401(k) With No Employer Match?

Deciding whether to contribute to a 401(k) without an employer match is a significant financial decision. While the absence of matching contributions might make such plans seem less appealing, they still offer benefits that can support long-term retirement planning. Weighing these advantages against other investment options is crucial.

Eligibility Requirements

Eligibility requirements for a 401(k) plan are typically set by employers and often include a minimum age, usually 21, and a required service period, which can range from immediate eligibility to up to one year of employment. The Employee Retirement Income Security Act (ERISA) governs these criteria to ensure fair application across the workforce.

Recent legislative changes have expanded access to 401(k) plans for part-time employees. Starting in 2024, the SECURE Act 2.0 mandates that long-term, part-time employees who work at least 500 hours per year for three consecutive years are eligible to participate. This change aims to broaden retirement savings opportunities for more workers.

Contribution Caps

Contribution limits define how much employees can save in a 401(k) each year. In 2024, the IRS set the annual contribution limit at $23,000 for employees under 50. Those aged 50 and above can take advantage of a catch-up contribution provision, allowing an additional $7,500, for a total of $30,500.

Including employer contributions, the total contribution limit is $69,000 for employees under 50 and $76,500 for those eligible for catch-up contributions. These caps allow individuals to maximize tax-advantaged savings.

Tax Treatment of Contributions and Earnings

The tax advantages of 401(k) plans are a key factor to consider. Contributions to a traditional 401(k) are made with pre-tax dollars, reducing taxable income for the year. For example, an employee in the 24% tax bracket who contributes $15,000 would save $3,600 in taxes.

Earnings within a 401(k) grow tax-deferred, allowing investments to compound without immediate taxation. Over time, this can significantly increase the account’s value. For instance, a 401(k) earning a 7% annual return grows more efficiently than a taxable account since the growth is not taxed until withdrawal.

Roth 401(k) plans, by contrast, involve after-tax contributions, meaning they do not lower taxable income in the year of contribution. However, qualified withdrawals during retirement, including earnings, are tax-free, offering a different type of tax benefit.

Penalties for Early Withdrawals

Early withdrawals from a 401(k) typically incur a 10% penalty if taken before age 59½, in addition to regular income tax. For instance, withdrawing $10,000 while in the 22% tax bracket would result in a $1,000 penalty and $2,200 in taxes, totaling $3,200.

Some exceptions to the penalty exist, such as for certain medical expenses exceeding 7.5% of adjusted gross income, permanent disability, or withdrawals under the substantial equal periodic payments rule. Legislative changes, such as those under the CARES Act, may also temporarily modify withdrawal rules.

Rollover Options

When changing jobs or retiring, rolling over 401(k) funds can preserve their tax-advantaged status. Funds can be transferred to another qualified retirement account, such as an IRA or a new employer’s 401(k), without triggering taxes or penalties.

Direct rollovers, where funds are transferred directly between financial institutions, are the easiest option and avoid the mandatory 20% federal withholding tax associated with indirect rollovers. Rolling funds into an IRA often provides more investment options, though it may lack some protections offered by employer-sponsored plans.

Administration and Fees

The fees associated with 401(k) plans can affect net returns on retirement savings. These fees generally fall into three categories: administrative fees, investment fees, and individual service fees. Administrative fees cover costs like recordkeeping and compliance and vary depending on the plan provider.

Investment fees, such as expense ratios for mutual funds or ETFs, often represent the largest cost. Actively managed funds tend to have higher fees than passively managed index funds, and these differences can significantly impact account growth over time.

Individual service fees, such as charges for loans or withdrawals, are also worth considering. Reviewing the plan’s fee disclosure document is essential to understanding the overall cost structure. Comparing these fees to those of other investment vehicles, such as IRAs, can help determine the most cost-effective option for retirement savings.