Is a 401(k) a Retirement Plan?
Key takeaways
It’s an important part of your retirement strategy but using a 401(k) alone could leave you vulnerable.
A financial advisor can help you create a strategy to diversify your sources of income in retirement.
The Northwestern Mutual Planning & Progress Study finds that 75 percent of those who are working with a financial advisor say they feel they will be financially prepared for retirement.
Andrew Weber is a senior director of Planning Philosophy, Research and Guidance at Northwestern Mutual.
If you are enrolled in your company’s 401(k), you may think you are on track with your retirement plan. The convenience and built-in tax advantages of your 401(k) does make it one of the most effective ways to save for retirement. But is a 401(k) a retirement plan? Well, not quite.
Let’s fast forward a few years. When you get to retirement, you’ll need a strategy that accounts for income that lasts for the rest of your life, market volatility, taxes, health care, inflation, and legacy planning and merges it all with the lifestyle you want to enjoy. A 401(k) can be an important part of that strategy. But you’ll likely want more than just investments in a 401(k) to help you manage your own income in retirement. Your financial advisor can help you begin to incorporate these additional elements today and design a personalized plan for you.
Doing so just might give your nest egg a welcome boost. The 2024 Northwestern Mutual Planning & Progress Study found that 75 percent of Americans who work with an advisor say they feel they will be financially prepared for retirement when the time comes vs. 45 percent without an advisor who feel the same. Plus, 64 percent of those working with a financial advisor say they feel financially secure compared to 29 percent who don’t.
of those working with a financial advisor say they feel they will be financially prepared for retirement when the time comes vs. 45% without an advisor who feel the same.
of those working with a financial advisor say they feel financially secure compared to 29% who don’t.
While a 401(k) can help you save and generate income in retirement, you’ll probably need a few more financial tools to protect you from other risks down the road. Here are some basics to know.
First, what is a 401(k)?
A traditional 401(k) is an employer-sponsored account that allows you to automatically save for retirement using pre-tax dollars from each paycheck. Pre-tax simply means the money is taken out of your check before taxes are paid, and that reduces your taxable income for the year.
For 2024, you can contribute up to $23,000, but if you’re 50 or older you can kick in an additional $7,500. Another perk: Many employers match some, or all, of your contributions (that’s essentially free money). Your 401(k) contributions can be invested in a variety of assets, but choices are usually limited to those offered as a part of your plan.
How a 401(k) works when you retire
While contributions to a traditional 401(k) aren’t taxed today, they will be when you start withdrawing from a 401(k) in retirement. At that time, you’ll owe ordinary income tax on those distributions. Keep in mind, the IRS requires you to begin taking annual 401(k) distributions once you turn age 73.
Those taxes will add up quickly and can significantly reduce the amount of income you receive from each dollar you saved. The impact is further amplified if you drift into a higher tax bracket. What's more, your taxable income also impacts Medicare costs.
Fortunately, there are ways to minimize the taxes you pay on income in retirement, but that will require some strategic planning and a few more tools.
The 2024 Northwestern Mutual Planning & Progress Study found that those who work with an advisor are much more likely to feel secure, have an emergency fund, long-term plan, clarity and confidence.
Retirement planning beyond your 401(k)
The most effective retirement plan strategies go beyond the 401(k) and diversify your sources of income to provide stability and tax flexibility in retirement. Here are a few additional income sources that typically make up a well-diversified retirement plan:
Social Security: Social Security benefits aren’t affected by the market and will provide steady income for the rest of your life. It’s a stable component of your plan that helps smooth market volatility and longevity risk (outliving your savings). While you can begin collecting Social Security when you turn age 62, you may want to wait and allow your benefit to grow, which you can do up until you turn 70. A lot of younger folks assume Social Security won’t be around when they retire. However, even without changes, it will likely be able to pay retirement benefits for years to come.
Roth accounts: With a Roth IRA (or Roth 401(k)), your money is taxed before you contribute it. The money grows tax free, and in general it won’t be taxed when you withdraw it later in retirement. That can help you be more tax efficient in retirement. For example, if you generate $50,000 in income and half is pulled from your Roth IRA and the other half is from your IRA, only $25,000 (the portion from your IRA) would be taxed.
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Traditional investments: Beyond your qualified investment accounts (401(k)s, IRAs or their Roth counterparts), investments can also help you grow your money over time and manage your taxable income. A brokerage account won’t confer tax advantages (dividends and income will all be taxed as they are distributed or earned), but you can use strategies, such as tax-loss harvesting, to modify your taxable income for the year. Keep in mind that assets held in brokerage accounts are also good for those who want to retire early because you have access to the money before age 59 and a half.
Annuities: Unless you’re lucky enough to retire with a pension, an income annuity is a comparable source of guaranteed income. You may also want to consider using an accumulation annuity to save for retirement when you’re younger. An annuity, quite simply, is a contractual agreement with an insurance company that will provide you guaranteed, regular payments in retirement. An annuity helps manage longevity risk because it can serve as source of income for the rest of your life.
Health savings accounts (HSAs): These are tax-advantaged accounts used to reimburse health care expenses. While helpful for those in their working years, HSA accounts are especially useful for retirees as health care costs are one of the largest expenses in retirement.
Whole life insurance: Life insurance can be another powerful tool to supplement your retirement income. The policy itself builds cash value as you pay your premiums. This accumulated cash value doesn’t experience ups and downs like the markets and can be used at any time for any reason, including retirement income*. This can be especially helpful during periods of stock market volatility.
Cash reserves: Having liquid cash reserves in a high-yield savings account will come in handy for unexpected expenses that pop up in retirement.
Social Security is an important part of your financial plan.
Your financial advisor can show you how Social Security will work to reinforce your retirement savings. And they’ll show you how it can help you live the life you want in retirement.
Let's get startedYour 401(k) is an important piece of the retirement puzzle, but a robust retirement plan leans on a diverse mix of income sources, in addition to your 401(k), to create the income you'll need for the retirement you dreamed of. A financial advisor can help you build a plan for retirement, starting with recommendations about the best ways to save when you’re young all the way to the best ways to withdraw your money once you’re in retirement.
*The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement retirement income will reduce the death benefit and may affect other aspects of the policy.
This publication is not intended as legal or tax advice. Consult with a tax professional for tax advice that is specific to your situation. All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against a loss.
Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®, and CFP® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.
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