Finance expert Dave Ramsey has a major warning for Americans planning their retirement
A retirement fund is one of the most important things that people allocate a portion of their earnings towards. Now, best-selling author and personal finance guru, Dave Ramsey, has shared a controversial take on Americans investing in 401(k) plans for retirement. Sharing two blogs on his website, Ramsey shared advice on the things people should keep in mind regarding retirement plans and Individual Retirement Accounts (IRAs).
A 401(k) is an employer-sponsored retirement savings plan that allows workers to save and invest a portion of their income on a tax-deferred basis. The contributions to the plan are deducted automatically from the paycheck and invested in options chosen by the employees. The plan holders can also match the employer's contributions to add to the savings. Ramsey explained in his blog that contributions made to a traditional 401(k) reduce taxable income as they are not subject to income tax. He added that it is important to note that an IRA is not an investment itself. “It’s the account that holds your investments and determines how they’re taxed by the government,” he wrote. This is because the withdrawals from a traditional 401(k) in retirement are treated as ordinary income, and taxes are owed on the withdrawal amounts. “You get the tax break now, but you’ll have to pay the tax man somewhere down the line,” Ramsey wrote, adding that taking a Roth 401(k) plan would be more beneficial to enjoy tax-free withdrawals as well.
Ramsey explained that a Roth 401(k) is funded with after-tax dollars, meaning contributions are taxed before they enter the account. Thus, unlike traditional 401(k), the contributions do not reduce taxable income, but the withdrawals ultimately qualify as tax-free earnings. “Both types of tax advantages are great, but if your employer offers a Roth 401(k), we always recommend taking that option. Allowing your money to grow tax-free for decades and then not having to worry about taxes when you’re living out your retirement dreams? Sign us up!” Ramsey wrote.
According to Ramsey, a 401(k) account may look like a great investment, but it isn't that easy. According to the IRS, contributors can't withdraw funds until they cross the age of 59, without incurring a 10% penalty and paying taxes. "But there is a loophole: 401(k) loans allow you to use your retirement savings without paying penalties or taxes as long as you pay the money back. Of course, doing this comes with a bunch of rules, and things can go really wrong, really fast," he wrote.
In a separate blog, Ramsey explained that for people with mounting debt, it is best to pause their 401(k) contributions until they clear their dues. Emphasizing stability before growth, he laid out a seven-step plan in which paying off debt aggressively and building an emergency fund come before investing in a retirement account. However, experts told NASDAQ that this idea may not be suitable for everyone.
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