A recent IRS ruling grants permission to an anonymous company to allow part of an employee’s contribution to be directed toward student loan payments or health reimbursement accounts, in addition to the well-known 401(k) retirement plan. The 401(k) is a savings tool for retirement that many companies in the United States offer. So, the question to this financial news is: Is this a good idea? In this article, we’ll explain how this ruling could impact other companies if it becomes widely applied.
Advantages of flexibility in allocating contributions according to employee preferences
This past August, the IRS sent a letter to the company showing that more flexibility with their 401(k) plans accounts was possible. This way, at the beginning of each year, employees can choose where to allocate their funds, and if no choice is made, the contributions automatically go toward retirement. This option is unfamiliar to many, but if it were applied to all companies, it could be highly beneficial.
Allowing employees to allocate their contributions to other needs beyond retirement could improve their overall financial situation in certain ways. Employees could ease many financial worries outside their retirement years. Thus, using contributions to pay off medical or educational debt could actually help them achieve effective retirement savings in the long run. However, is it always the best option to allocate contributions this way?
Disadvantages of redirecting contributions away from retirement (401 k plans)
What could be wrong with this IRS ruling?On the downside, redirecting 401(k) plans contributions away from retirement could have significant drawbacks for many individuals. One major downside is the loss of compounding power (reinvesting gains to generate more over the long term). In fact, many Americans are already behind on their retirement savings, and redirecting contributions could leave them even further behind.
The average retirement savings for individuals aged 55 to 65 is $185,000, according to the Federal Reserve. Additionally, statistics reveal that one in four has no savings at all, including 27% of those already retired. In this context, although it may seem tempting, it’s ideal to maintain the status quo, unless addressing a considerable debt.
