As of 2018, 58 million workers in America were actively participating in 401k planning. For many, opening and contributing to a 401k becomes an option through work and while it is often encouraged, it is not always explained.
If you have a 401k or are considering opening a 401k, it’s important that you know a little bit about how it will work and what it will mean for your personal wealth. Is a 401k an asset? If so, what type of asset is it?
As you know by now, we’re committed to helping you learn more about financial assets and related opportunities that are available to you. We offer resources that explain how, when, and why you can grow your wealth.
Now, let’s tackle the question of 401ks, whether or not they’re an asset, and what they mean for your financial status.
What is a 401k?
Let’s start with the basics. At its simplest, a 401k plan is a retirement account that many employers offer. Why are 401ks tied to employment?
When you open a 401k account, you agree to a defined contribution that automatically comes out of your payroll. This sum of money is not taxed before it enters your 401k. This allows you to put away more money at a time than you would with something like a traditional savings account.
What happens to this money once it’s in your 401k? Your contributions will be matched (at least partially) by your employer. Most 401k plans allow you to decide how you want this money to be invested.
Are There Liabilities When You Open a 401k?
The best-case scenario is to open a 401k with a 100% match from an employer and solid investments that continue to grow over the years. However, any investment endeavor is subject to liabilities, including your 401k. How can you minimize risk?
If you are allowed to choose how your 401k plan is invested, do your research. Invest in stock that isn’t as volatile, including bonds that may not offer as high of a return but aren’t as likely to cause you financial loss. In addition, make sure to diversify your portfolio.
Remember, the younger you are, the more risks you can afford to take. And you can recover from mistakes. As you get closer to retirement, it’s crucial that you focus on building your stable assets (such as your traditional savings account) than you do your volatile assets.
Is a 401k Considered an Asset?
Technically, a 401k is considered an asset. In a very literal sense, we consider assets anything that contributes to your net worth. Basically, if it belongs to you and it holds value, it is an asset.
Some people bring a little more nuance to the discussion of what is and is not an asset. If you consider an asset the opposite of a liability, then you may not consider a 401k an asset simply because it is vulnerable to the stock market.
Sounds a little confusing, right? The best way to make sense of a 401k is to understand how it’s going to affect you, personally. Let’s take a look at some important questions that determine whether or not a 401k is the right investment for you.
Liquid vs Fixed Assets
Liquid assets are those that you can use right away or with relative ease. Most simply, that includes your checking and savings accounts. When we talk about things like emergency funds, we’re talking about liquid assets that you can use whenever you need them.
Fixed assets, also referred to as permanent or illiquid assets, are not as easy to take advantage of in the immediate future. Fixed assets often come with some form of penalty if you try to take advantage of them at the wrong time. This can include real estate, annuities, and retirement accounts–including your 401k.
When and How Can You Use the Money in Your 401k?
If a 401k is a fixed asset, when and how can you actually use that money? The simple answer is that 401k is designed for use after you reach the age of 59 1/2 years of age. If you pull money out of your 401k before you reach that age, you may be subject to an early-distribution penalty tax in addition to any regular taxation on that money.
Is a 401k Taxable?
When you’re filing your yearly taxes, you don’t need to include the money in your 401k as part of your yearly earnings. This is one of the reasons that opening a 401k can have immediate and long-term benefits.
However, a regular 401k becomes taxable once that money is available to you. In other words, once you start pulling funds from your 401k, it becomes part of your taxable income.
There is one exception. If you have a Roth 401k, you pay taxes upfront, rather than in the future. What that means is that your personal contributions come from your after-tax paycheck, but the amount you pull from your Roth 401k after you reach 59 1/2 years of age will not be taxed.
Is a 401k Marital Property?
Sometimes, we want to know more about our own assets and what they mean in regards to marital property. Marital property is any shared property (including both liquid and fixed assets) that both spouses have some level of entitlement to. You may be wondering, what happens to my 401k in the event of a divorce?
Typically, both partners are entitled to some portion of a 401k if it grew in worth during the course of the marriage. What that boils down to is that as long as you had and contributed to your 401k while married, you will owe some of that many to your former spouse in the event of a divorce.
Put Your Money Where It Is Most Advantageous to You
All in all, a 401k is considered an asset. That being said, it may not be the best place for you to put your money at this time. We hope that this overview of how 401ks work has given you the insight you need to determine whether or not a 401k is right for you.
Want to find more about how you can grow your wealth? Sign up for our free Infinite Banking Course to get started.