Employers sponsor 401k plans that provide a means for their employees to save and accumulate assets for retirement in individual tax-advantaged accounts. Employees contribute a percentage of their salary on a monthly basis, which can amount to up to $16,500 annually. These plans are governed by particular guidelines that can include the buying and selling of individual stocks, but are most often set up to invest in mutual funds, which then make decisions on which stocks and other assets to buy and sell.
All contributions to a 401k account are deducted from an employee's paycheck before deducting federal taxes, which makes this an ideal pretax savings vehicle. All earnings accumulate without the necessity to pay taxes on capital gains or dividends until the money is withdrawn for retirement. Individuals seeking to buy and sell stocks should ideally look to do so within this type of account, as capital gains would otherwise be taxed at either the regular income tax rate for trades concluded within a year or the generally lower 15 percent for long-term capital gains that occur after 12 months.
Corporations often provide an option for employees to accumulate company stock, often at a discount to the current market price if it is a publicly traded company. The only rule governing such purchases is the annual cap on contributions, but employees should be wary of owning too much stock in their employers, regardless of how much that practice is touted within the company. Owning too much stock in one company leaves the shareholder exposed to potential declines in earnings, market value and even bankruptcy. Unless otherwise prohibited within the plan documents, employees are free to sell company stock within their 401k accounts.
Employers typically avoid the extra administrative paperwork that accompanies employee trading in individual stocks, which is why they offer a choice of mutual funds in which to invest. Those funds, in turn, may purchase all manner of stocks, bonds, commodities and other assets, which removes the burden of employees having to make those decisions. Investment managers are generally given guidelines chosen by the employee, which can include risk tolerance, limited exposure to the stock market and other caveats. The other benefit of using mutual funds within 401k accounts is that the best-run funds are disciplined in approach and execution that can limit any losses to a reasonable level. Employees who trade in individual stocks may spend an inordinate amount of time researching and following the stock market, sometimes during work hours, and substantial losses may well affect job performance. As there are no predetermined rules on how much risk an employee may assume, this approach may result in significant difficulties.
For employees who wish to have the maximum flexibility and control to direct their own 401k plans, the rules permit individuals to buy and sell individual stocks. This can only occur, however, with employer support and participation. As most companies do not wish to expose themselves to the potential risks, extra paperwork and employee distractions, they do not permit such self-directed plans. Those who still want to trade individual stocks within a tax-deferred retirement account can always turn to an IRA, although business owners and entrepreneurs are more likely to maintain self-directed plans.