retirement savings  |  august 4, 2022

401(k) Plans Still Make Sense. Here Are Four Reasons Why.

These tax-advantaged accounts remain the backbone of a retirement savings strategy, despite what naysayers might argue.


Key Insights

  • 401(k) plans are an important and effective way for investors to prepare for retirement.

  • Retirement plans increasingly make it easy for employees to save automatically.

  • Plans offer significant tax benefits through traditional and Roth contributions.

  • The vast majority of retirement plans offer an employer matching contribution.

  • Target date investments, offered by 97% of retirement plans served by T. Rowe Price, make investing and diversification easy.

Roger Young, CFP®

Thought Leadership Director

From time to time, you may see articles on the drawbacks of 401(k) retirement plans. While it is important to understand the limitations of any investment account, when pundits start claiming that 401(k) retirement plans don’t make sense for most people, I feel the need to speak up. When I was a financial advisor, nearly all of my clients—across a wide variety of income levels—built their foundation for retirement with 401(k) plans. I would hate to see people read negative articles and decide not to participate in retirement plans.

I should state upfront that I work for an investment management company that serves investors in 401(k) plans and other types of accounts. I am a longtime advocate of retirement plans and can support my view with analysis and real-life experience.

There are four major benefits of retirement plans that stand out to me:

1. Automatic Saving

The behavioral benefit of automatically saving for retirement each pay period should not be understated. There is abundant research showing that people tend to stick with default actions, such as automatically contributing to a 401(k). Data from retirement plans served by T. Rowe Price1 in 2021 showed that 85% of employees participated in their plan if it was set up for auto-enrollment. For other types of plans, the participation rate was only 39%. The gap is even wider for workers under 30. Fortunately, employers’ adoption of auto-enrollment has steadily risen from 44% to 64% over the past seven years. These figures tell a story: People need help with saving, and retirement plans are increasingly helping them.

2. Tax Benefits

Considering the downward trend in statutory tax rates over recent decades, do "tax advantaged" retirement accounts really help? Having conducted thorough analysis in this area, I am confident they do.

It’s true that while you get a nice tax break on the money you contribute to a traditional 401(k) account, once you start making withdrawals in retirement you will pay taxes on every dollar you take out. However, many people will have a lower effective tax rate in retirement than the marginal rate during their working years. That makes deferring taxes via a 401(k) plan beneficial. Even if your tax rate doesn’t decrease in retirement, tax deferral generally works out better long term than a nonretirement account.

If you expect a higher tax rate later, Roth contributions may help you, and 83% of retirement plans now offer them. You pay taxes on the money you contribute to a Roth, but after that, the principal and gains can be tax-free via qualified withdrawals. If instead you grew your portfolio using a taxable (nonretirement) account, even with income low enough to avoid taxes on long-term capital gains, a Roth account2 would still be at least as good tax-wise. Ultimately, tax-deferred growth, with either traditional or Roth savings, can go a long way toward meeting your retirement goals.

3. Employer Contributions

Taking advantage of an employer’s 401(k) match may be the first personal finance advice you get upon entering the workforce. It’s often referred to as “free money” and is a significant, straightforward, and common benefit. Eighty-six percent of plan sponsors with 5,000+ employees offer a match—plus over 76% of smaller plans. The most common match formulas incentivize employees to contribute at least 4% to 6% of their pay. Many employers contribute up to 3%, and matching formulas up to 4% or 5% are becoming more popular. Again, the trends have generally moved in the right direction, even during the pandemic. Could employers help workers in ways outside a retirement plan? Yes, but the combination of behavior encouragement and a well-established platform is very powerful.

4. Help with Investing—and Staying Invested

Have you ever been paralyzed by a bewildering array of toothpaste at the store? A similar feeling can come over retirement savers when it comes to investment selections. Fortunately, 97% of retirement plans offer target date investments, and often they are set as the default option. Target date investments are goal-oriented and automatically adjust your risk level over time. In addition, 84% of plans allow investors to automatically increase contribution percentages periodically, with nearly half of those plans setting auto-increase as the default. And, importantly, it is possible to get your money out before retirement if necessary, but there are large incentives not to do so. If you need help, your employer will likely provide education and guidance, regardless of your asset level.

Of course, there is a range of quality and cost among 401(k) plans. And all types of investment accounts have advantages and disadvantages. Regulations around retirement plans, taxation, and Social Security could all be changed to improve Americans’ retirement security. None of that leads me to believe that retirement plans don’t make sense for savers today.

I want clients to prepare successfully for retirement, regardless of what types of accounts or investments they use. Retirement plans have helped a lot of people, including me, and I encourage investors to continue reaping their benefits.

1All statistics about retirement plans are from T. Rowe Price Reference Point (PDF).
Assuming qualified Roth distributions. A qualified distribution is tax-free if taken at least 5 years after the year of your first Roth contribution AND you’ve reached age 59½, become totally disabled, or died. If your distribution is not qualified, any earnings from the Roth portion will be taxable in the year it is distributed. These rules apply to Roth distributions only from employer-sponsored plans. Additional plan distribution rules apply.

Important Information

This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and not intended to suggest any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.

The views contained herein are those of the authors as of July 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

All investments are subject to market risk, including the possible loss of principal. The principal value of target date investments is not guaranteed at any time, including at or after the target date, which is the approximate year an investor plans to retire. These investments typically invest in a broad range of underlying portfolios that include stocks, bonds, and short-term investments and are subject to the risks of different areas of the market. In addition, the objectives of target date investments typically change over time to become more conservative.

View investment professional background on FINRA's BrokerCheck.



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