What Does the 401(k) Actually Get Right?

In this episode, Wes Cuprill, CFP® walks through the core strengths of the 401(k) and why it remains one of the most powerful wealth-building tools available to American workers — despite its limitations. You'll learn about the undeniable advantages: employer matching (free money), portability across jobs, higher contribution limits compared to IRAs, tax-deferred compounding, and the behavioral design that automates saving before you ever see the money.

Chapters:
00:00:00 – Why 401k Plans Are Incredibly Powerful Today
00:01:02 – Employer Match Benefits and Job Mobility Advantages
00:03:05 – Tax Deferred Growth and Higher Contribution Limits
00:04:48 – Behavioral Psychology That Forces Automatic Savings
00:06:46 – Maximizing Your 401k for Financial Independence

Transcript

For the last few weeks, I have been talking about the history of retirement in general, the history of retirement in the United States. I've talked about how the 401(k) came into being and I've discussed its evolution over the last 45 years. And today what I want to talk about is what I think the 401(k) does well, what it gets right. Now it's quite possible through the course of this conversation you might sit there and go, "Well, yeah, we knew all of this." But I think it's always important to revisit these things and really have a firm understanding of why the 401(k) should form a large portion of your overall investment strategy.

there's no denying that the 401(k) is incredibly powerful. And for those of you who have access to one, it is crucially important that it does form the nucleus of your overall retirement or long-term wealth building strategy. So let's dive into some of the things that I think the 401(k) does really well, starting off with free money. For those of you who have access to a 401(k), many employers will offer an employer match. They'll say, "Hey, if you're contributing X percentage, we will also match a certain percentage." So it is a great benefit that many employers offer. And if you are somebody who does have access to an employer match,

implore you to ensure that you are achieving the full match. So whatever you need to be putting away into your 401(k) to maximize that employer match, it is crucial that you do so. Because if you want, you are literally leaving money on the table. So that's one of the best things that the 401(k) does well. Now, of course, it comes at the expense of the company not taking care of you fully anymore like they used to in the old pension system. But again, it is what it is. If they are offering a match, make sure that you are receiving the full match. Another thing that the 401(k) does well compared to the traditional pension plan system is portability. If you want to leave your employer, you are able to do so while taking your 401(k) with you and the vested balance that you have in that plan. In the old system, the pension system, you weren't able to take your pension plan with you. If you left your employer, it came with forfeiting that pension that you had built up with that employer. So you had to make sure that if you were going to another employer, per se, that they offered a similar pension system. So the 401(k) does enable you to move around,

is a great thing, especially in today's day and age, where people do leave their employers. It is far more rare now to stay with a company for, say, 30 or 40 years.

Another thing the 401(k) does well, and this is compared to, say, traditional IRAs, is that they offer higher contribution limits. You can put more money into the 401(k), and it does seem that every year those contribution limits are increasing to at least keep pace with inflation. So compared to a traditional IRA, you're able to put more money away into the 401(k) plan, enabling you to save more over time. That's one of those things I encourage people to do, is try and put as much money into your 401(k) plan that you can.

Another thing that the 401(k) does well is it enables you

grow your money tax-deferred.

I'm talking about the traditional 401(k) components.(...) You're saving aside a percentage of your pre-tax income into the 401(k), and you're enabling it to grow on a tax-deferred basis, and it doesn't get taxed until you withdraw it. So this enables you to achieve compounding interest on tax-deferred money year over year for a long-term period of time. That's another thing that the 401(k) does well, is it forces you to think in a long-term mindset. I think this is something that us humans struggle with, is thinking long-term, or often so concerned with the here and now that we don't think about what's going to happen 20, 30, let alone 40 years down the road.(...) Since the 401(k) cannot be tapped into until later in life, it forces us to make long-term decisions, which is one of the greatest things that the 401(k) does. You combine this with another behavioral piece. This is what causes the 401(k) to really help us against our human nature, if you will. The behavioral component of deferring a percentage of your income before it even hits your bank account is one of the most powerful behavioral finance components of the 401(k). It forces us to save money and not even realize that we're doing it.

Let's say you were given your pre-tax paycheck, and then it was entirely up to you to figure out what to do with it, including paying the taxes.

I'm not saying that we wouldn't do the things that were necessary to do, but it becomes a lot harder. We're then forced to pay our taxes, but then we're also forced to save our money. We're saying, "Hey, we've got all this money now. We need to make sure to put some away." Well, the behavioral component of just automatically deferring that money into our 401(k) without even seeing it, without ever hitting our bank accounts, is one of the most powerful behavioral pieces that the 401(k) does. It forces us to save money without even thinking about it. I think at the end of the day, that's one of the hardest pieces when it comes to building wealth over time. It's trying to defer our pleasure, if you will, for something in the future. As human beings, we're not really wired to do that. I've discussed this overall concept in the past, how, again, humans, we're living longer than we ever have, and we're having to make decisions that impact our future selves, not our current selves. That's very, very hard in today's day and age, where we want everything right away, and we're bombarded with these messages of, "Now, now, now, you want to buy things now. You want to be rich now."

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We lose sight of the fact that you can grow money over time by doing things slowly. If you do things well,(...) slow often means wealth, and the 401(k) is one of the best tools for building wealth over time. That's why, again, I will always be a fan of the 401(k) because it really does form a good nucleus for a strong long-term wealth-building strategy. While next week I will talk about some of what I view are the downsides of the 401(k), I think it's important to always remember how powerful it really is. In light of the fact that pension systems no longer exist, or rather they exist in a very limited capacity, and we are now on our own to build our retirements and our financial futures, it's important to take advantage of the tools that are at our disposal. If you have access to a 401(k), I implore you to take full advantage of all of its components, especially the employer match and making sure that you are deferring as much money as you can into that plan. I encourage everybody every year, assess, "Can I afford to put even more into my 401(k)? Can I sacrifice a little bit more today so I can put more into that account so that it grows even more over time?" Because ultimately when we retire, we at least want to maintain our existing lifestyle, but wouldn't it be great if you had enough money that you could actually

your current lifestyle when you do retire and say, "You know what? I'm used to spending X amount, but I can actually increase that to Y amount." That will enable you to then go do all of the things on the bucket list that you haven't been able to do yet, all while having the time and the energy to be able to do so.

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That's just a quick conversation about what I think are the great things about the 401(k) and again, why I think it should always be a piece of people's wealth building strategy if they have access to one through their employer.

But again, it comes down to a lot of the behavioral pieces.

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This is where I may plug myself and go, "Listen, if you're looking for somebody to help you coach you through this, especially the long-term decision making, that's where a financial advisor really comes in handy. That's where somebody can really help coach you and help you see, "Okay, if we make these decisions now, what does it mean down the road?" Being able to get clarity about that, I really think enables us to

aside our immediate needs so that we know in the future we are going to be taken care of. If you have any questions about that, we'd love for you to reach out. Let me know, Wes Caprill at MoneyAndClarity.com or go to VisitWithMC.com. That being said, I'll see you next week where we have a discussion about what I think are some of the downsides to the 401(k) and why

make up your entire financial picture.