Understanding Your 401(k): Five Key Things You Need to Know

 Understanding Your 401(k): Five Key Things You Need to Know

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Hi, I’m Aju John, a financial professional and retirement planning specialist. My goal is to help people save money for retirement by making informed financial decisions. Today, we’re talking about 401(k)s—one of the most popular investment vehicles in the U.S.

Despite their popularity, many Americans don’t fully understand how 401(k)s work, but that changes today. I’ll cover five critical things you need to know about your 401(k):

1. Taxes – When and how you pay them.

2. Fees – Yes, your 401(k) has fees that can impact your savings.

3. Control – How much control do you really have?

4. Limitations – The restrictions you should be aware of.

5. Alternatives – Other investment options beyond your 401(k).

Let’s dive in.

1. Taxes: When and How You Pay Them

A 401(k) helps you defer taxes, not avoid them. The taxes you pay depend on whether you have a Traditional 401(k) or a Roth 401(k).

Traditional 401(k): You contribute pre-tax dollars, meaning your taxable income is reduced today. Your money then grows tax-deferred until retirement. When you withdraw funds, you pay taxes on the entire amount at your ordinary income tax rate.

Roth 401(k): You contribute after-tax dollars, meaning you pay taxes on your income upfront. The advantage? Your money grows tax-free, and you pay no taxes on withdrawals in retirement.

Which is better? It depends on your future tax situation. Many assume they’ll be in a lower tax bracket in retirement, making a traditional 401(k) more attractive. However, if you anticipate higher income or believe tax rates will rise, a Roth 401(k) might be the better choice.

2. Fees: How Much Are You Really Paying?

Your 401(k) is not free—it comes with fees, primarily in the form of an expense ratio on your investment funds.

Even a small percentage difference can cost you hundreds of thousands—or even millions—over time.

For example, if you contribute $1,000 per month for 40 years at a 10% annual return:

With a 0.07% expense ratio, you’d have $5.2 million at retirement.

With a 0.85% expense ratio, you’d only have $4.2 million—losing $1 million to fees.

Action Step: Check your 401(k) plan’s expense ratios and ensure you’re not overpaying for fund management.

3. Control: Who Really Manages Your Money?

When investing in a 401(k), your control is limited in two key ways:

1. Employer Control:

Some employers match your contributions—free money that helps you grow your retirement savings faster.

However, many companies have a vesting schedule, meaning you must work for them for a set period (e.g., 5 years) before you own 100% of the matched funds.

2. Investment Options:

You can’t invest in individual stocks—your choices are typically limited to pre-selected mutual funds.

You likely can’t invest in real estate, private businesses, or alternative assets within your 401(k).

If you leave your job, consider rolling your 401(k) into an IRA, which often provides more investment options and lower fees.

4. Limitations: A 401(k) Shouldn’t Be Your Only Investment

While a 401(k) is a great place to start, it has significant limitations:

You’re limited to employer-selected funds.

Your money is 100% tied to the stock market.

You can’t easily access your money before retirement without penalties.

True diversification means investing outside of just your 401(k).

5. Alternatives: Other Ways to Build Wealth

The three biggest wealth-building asset classes in the U.S. are:

1. Stocks – Beyond your 401(k), you can invest through:

IRAs (Traditional or Roth)

Brokerage accounts (index funds, ETFs, individual stocks)

2. Real Estate – Investing in rental properties, commercial real estate, or REITs can create passive income and hedge against inflation.

3. Businesses – Owning a business or investing in startups can provide high returns, though it carries more risk.

Final Thoughts

Your 401(k) is a great starting point, but it shouldn't be your only investment strategy.

Understand your tax implications (Traditional vs. Roth).

Minimize fees to maximize long-term growth.

Diversify outside your 401(k) into other investments like real estate, IRAs, and private investments.

If you’d like to stay updated on market trends, financial strategies, and economic news, and or got questions? Drop them in the comments—I’d love to help!