With so much volitility in the stock market throughout the early 21st century, some investors may wonder whether a simple savings account might be a better choice than a 401k plan. While the 401k is specifically designed to help you maximize retirement savings, it has drawbacks that aren't typically associated with a savings account. Compare the advantages and disadvantages of these two types of accounts to determine which one best suits your financial goals.
Advantages of Savings Accounts
Savings accounts are open to anyone, regardless of how much money they have and where they work. These accounts are fairly simple to open and use, and many banks will waive fees if you meet minimum saving thresholds. Even if you can't meet these thresholds, the fees associated with a savings account are often low. These accounts are also highly liquid, which means you can access the money with ease. Because the U.S. Treasury guarantees up to $250,000 per depositor per insured bank, so the money in your savings account is safe and secure.
Disadvantages of Savings Accounts
Perhaps the biggest disadvantage of a savings account is the low rate of return compared to a 401k plan. According to a 2011 article in "USA Today," the average rate of return on a savings account in the U.S. is less than 1 percent. While online banks offer interest rates that are five times higher on average than brick-and-mortar banks, the average rate is still extremely low compared to the potential rate of return on a 401k.
Advantages of 401k
The biggest advantage of a 401k plan is that it enables you to save for retirement using pre-tax dollars. You have to pay taxes on this money when you retire, but your tax rate is often much lower by this time. Some employers match your 401k contributions, allowing you to save even more. These plans also have fairly high average return rates. For example, consider a 401k plan whose funds were invested in the S&P 500. According to the Bankrate website, the S&P 500 provided an average annual rate of return of 10.1 percent from 1970 to 2009.
Disadvantages of 401k
While 401k plans provide fairly good returns on average, they can also be volatile depending on where your money is invested. For example, the annual rate of return on the S&P 500 varied dramatically between 1970 and 2009, even though the annual average remained around 10.1 percent. During this 30-year period, the S&P 500 experienced single years in which the rate of return soared as high as 61 percent or dropped as low as -41 percent. The federal government also places limits on how much you can contribute to a 401k each year. As of 2012, you can invest a maximum of $17,000 if you are under 50 years old or $22,500 if you are 50 or older. Unlike savings accounts, 401k plans are not liquid. They money is difficult to access, and you should expect to pay severe penalties if you withdraw the money before you retire.
- stock market image by Sydney Alvares from Fotolia.com