Over The Cliff With A 401(K)

To begin discussing this subject let us be aware of all the facts we know about a 401(k).

What is a 401(k)?

A 401(k) is nothing but a retirement savings plan sponsored or paid by the employer. The employer lets the employee save and invest a certain percentage of their pay before it is taxed. Point to remember in a 401(k) is that you will only be taxed when the money is withdrawn and not when it is deposited.

So would it be worthwhile to contribute to 401(k) with a 3-year cliff?

Your question to me could be what exactly is a cliff? Is it the edge of a mountain or the end to nowhere? A cliff is nothing but vesting. A cliff vesting is when an employee becomes completely vested in a specified period in time. So for example, you have fully vested in a company sponsored pension plan only after 5 years of full service.

Now, coming back quickly to the intended subject, the money that you invest in a 401(k) is all yours. So for example, you work for 5 years and leave your job, there will not be any effect on the investment that you had made in a 401(k). The only thing that changes is the contribution of the employer because that depends on the vesting period. It is a good plan with good benefits. However, it is not something that is quickly recommended to young professionals.

To begin with, a 401(k) is ideally to be kept as a secondary hold. The idea is to maximize other resources and then fall back on this vehicle. My advice would be to begin investing in the Roth IRA and contribute to it till you do not reach the maximum limit. Once you have touched the limit, look towards the 401(k). This has a great advantage, the first and foremost being diversification.

There is a different school of thought who might suggest that given the pretax nature of 401(k), you will have more money to start with and then go ahead with your contributions to the Roth IRA.

Remember, most successful finances are largely behavioral. So a 401(k) being an automated process, really makes you keep aside a certain amount of investment, which otherwise would have been spent elsewhere. It actually is dependent on how you see yourself in 10 years time.