Both 401(k) accounts and savings accounts help save money for the future, but they are not the same thing. The 401(k) is designed to save money for retirement in the long term through investment in financial markets. However, 401(k) accounts come with restrictions on when funds can be accessed. Savings accounts have lower risks and do not have many restrictions, but they cannot be invested like 401(k)s.
What is the difference between 401(k) and savings accounts?
Primary goal:
401(k): Saving money for long-term retirement.
Savings account: Saving money for the short or long term or as an emergency fund.
Deposits and taxes:
401(k): Investing money before taxes are deducted from your paycheck; paying taxes when withdrawing funds.
Savings account: Depositing money that has already been taxed; paying taxes on earned interest.
Withdrawals:
401(k): Withdrawals are limited before age 59 and a half; withdrawals may be subject to monthly limits.
Savings account: You can withdraw cash from your savings account without paying penalties, but some banks may require you to maintain a certain balance in your account or charge fees. Banks may also limit the number of withdrawals or transfers you can make monthly. Always check with your financial institution to see if your savings accounts have any restrictions.
Investment options:
401(k): Usually invested in mutual funds; there may be other options available.
Savings account: Cash-based, and you cannot invest in mutual funds. The returns will only be the interest you earn, which will accrue and grow. However, you can choose the type of savings account you want: regular savings account, online savings account, high-yield savings account, money market account. Each type of savings account has its advantages and disadvantages, so it’s important to compare options before deciding where to place your money.
Earned returns:
401(k): The earned returns on a 401(k) account depend on market performance and the types of investments you choose. Your account balance will rise and fall over time and includes interest, dividends, and appreciation.
Savings account: Savings accounts offer an interest rate set by the bank or credit union, which is typically very low. However, the interest rate will not fluctuate as much as can happen in the stock market. Some banks offer higher interest rates, so don’t hesitate to shop around for the best interest rates for savings accounts.
Risks:
401(k): According to a 2021 study, 401(k) and IRA assets are the largest financial assets for most families, exposing them to risks from market downturns like the 35% decline due to economic fears from the pandemic in 2020. Additionally, most families invest in stocks in their retirement accounts, which can lose value quickly if market conditions change.
The insurance from the Federal Deposit Insurance Corporation (FDIC) helps protect up to $250,000 in any savings account from loss if the bank faces troubles. However, the money in these accounts carries inflation risks – that is, the returns do not keep pace with the inflation rate. If your savings account pays 2% interest, but inflation is at 9%, then your money is losing value.
Limits:
401(k): The Internal Revenue Service (IRS) sets the amount you can contribute to your 401(k) account each year. In 2022, this amount is $20,500 ($27,000 for individuals over age 50).
Your bank may set a maximum deposit limit for your savings account, but generally, you can save as much as you want. But remember that only the first $250,000 is insured against loss by the Federal Deposit Insurance Corporation, per account.
Option
Combining the Best of Both Worlds
Both 401(k) plans and savings accounts help you work towards achieving your savings goals. Work with your employer to set up automatic contributions to your 401(k) account, then add money to your savings account each month. By regularly funding both accounts, you’ll be prepared for anything that comes your way.
Conclusion
It’s essential to save money for the future, and whether you choose a 401(k) account or a savings account – or both – depends on your unique financial goals. Consider a savings account if you’re looking for immediate and low-risk access to cash for emergencies or short- to medium-term goals. But if you want to save for retirement and have a longer time frame to weather market fluctuations, and can wait until later to access your funds, a 401(k) account may be the better option.
Ultimately, the best way to save is to have both types of accounts. This will give you the flexibility to cover unexpected expenses while achieving long-term retirement goals.
Frequently Asked Questions (FAQs)
How much should I save each month?
While your income and expenses determine the amount you have available to save, aim to set aside at least 10% of your income each month. You can always save more once you build the saving habit.
What happens if I need to use funds from my 401(k) account?
Withdrawing funds from your 401(k) account before retirement can have several consequences. If you’re under age 59 and a half, you may face a 10% early withdrawal penalty unless you qualify for certain circumstances. If you don’t qualify, you may be able to take a 401(k) loan. Just remember that you’ll need to repay the loan with interest.
Source: https://www.thebalancemoney.com/401k-vs-savings-account-whats-the-difference-6748002
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