No matter how much you earn, saving money is extremely important. Whether you choose to put that money into a regular savings account or a 401(k) plan, you should familiarize yourself with each option's benefits and drawbacks.
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Advantages of regular savings accounts
A regular savings account -- the type offered by most banks -- lets you access your money whenever you want. You don't need to reach a certain age to withdraw funds from your savings account, nor do you need to justify your reasons for making a withdrawal. You're free to simply deposit and take out funds as you see fit. Additionally, if you open up a savings account at an FDIC-insured bank, your money will be protected for up to $250,000 per depositor on your account. This means your money can grow safely, and as long as you don't exceed the FDIC insurance limit, you won't risk losing out on any principal.
Disadvantages of regular savings accounts
While regular savings accounts are essentially risk-free, current interest rates are extremely low, which means you won't see a very sizable return on your investment. As of 2016, most regular savings accounts are offering 1% or less per year in interest. Additionally, when you open a regular savings account, the only money that gets added to it is the amount you contribute yourself. Whereas employers frequently offer matching dollars for 401(k) plan contributions, it's practically unheard of for a company to match contributions to a regular employee savings account. Finally, any interest you earn from a savings account is taxed as ordinary income, which is the same rate your salary is taxed at. This means that if you earn $1,000 in interest over the course of a year and are in the 30% tax bracket, you'll lose $300 of that interest to taxes.
Advantages of 401(k) plans
A 401(k) plan is a tax-advantaged retirement plan. Most people open up 401(k) plans through their employers. With a 401(k), your money can grow tax-free. By contributing, you can lower your tax burden up front, and you won't have to pay taxes on the money in your 401(k) until you withdraw it in retirement. Also, many employers offer matching programs where they'll contribute a certain dollar amount or percentage for every dollar you put in. This basically equates to free money. Finally, if you invest your 401(k) wisely, you could see a significant return on your investment -- one that's much higher than what the average savings account is currently offering.
Disadvantages of 401(k) plans
With a regular savings account, you can access your money whenever you please, but with a 401(k) plan, you can't withdraw the money you put in until your legal retirement age, which, as of 2016, is 59.5. If you withdraw money from your 401(k) prior to your retirement age, you'll not only pay taxes on the amount you take out, but also be subject to a 10% penalty. Furthermore, unlike money in a savings account, 401(k) investments are not FDIC-insured, and are therefore subject to losses in the event of a down market or poor investment choice. Though it's possible to mitigate this risk by diversifying your investments, the possibility of losing principal still exists.
A hybrid approach
Regular savings accounts and 401(k) plans don't have to be mutually exclusive. In fact, most people can benefit from having both at the same time. This way, you have immediate access to money in the event of an emergency, but you also have savings that can grow into a nice retirement nest egg.
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