As someone who frequently writes on retirement planning, I'm often asked if it's worthwhile to participate in a 401(k) plan if one is available. And, in most cases, the answer is a loud "yes."
One of the best things about 401(k)s is that you can put away far more money each year than you can with an IRA. 401(k) contributions are now capped at $19,500 for those under 50 and $26,000 for those 50 and up. IRAs, on the other hand, have a limit of $6,000 and $7,000, respectively.
These increased contribution levels not only let you save more for the future but also provide you with a greater tax break right away. Traditional 401(k) contributions are tax-deductible, allowing you to shield some of your current earnings from the IRS.
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- Also Read: Roth IRA Basics for Beginners: What’s There to Learn?
1. There’s no match
Many companies offer 401(k) plans to match employee contributions to some extent. These matches can differ in terms of generosity, with some being more giving than others. However, if your firm does not match your contributions in any way, 401(k)s lose a lot of their value.
As a result of the pandemic's impact, some companies have temporarily suspended matching. You don't need to abandon your plan if that's the situation with your company, but you would expect your match to return later this year or in 2022. If, on the other hand, you've never been provided a match and your employer has no intentions to change that, you might want to seek other ways to save.
2. High fees
High fees are common in 401(k) plans, and they can eat into your returns. These fees typically include administrative fees, which you have no influence over, and investment costs, which you can control to some extent but not always, as we'll discuss in a moment. If your administration fees exceed 1%, you should cancel your workplace plan right away and start a new account that won't charge you as much.
3. Limited fund options
Most 401(k) plans have at least a dozen different funds to choose from when it comes to investing your money. Some plans, however, have a narrower selection or not a very diverse one. And this could leave you not just dissatisfied with your investments but also paying higher fees than you'd like.
In general, in a 401(k), you can pick between actively managed mutual funds and index funds. The fees charged by index funds, which are passively managed, are typically far lower than those charged by actively managed mutual funds. However, if your 401(k) doesn't offer many index funds, you may want to consider investing your savings elsewhere.
Other retirement savings options
One thing that all 401(k)s have in common is that you can't buy individual stocks; instead, you're limited to several funds. IRAs, on the other hand, allow you to choose your equities, which may be a more efficient and cost-effective way to build wealth.
You can also put money aside for retirement in a standard brokerage account, which does not provide tax advantages like a 401(k) or IRA. That isn't the best solution because those tax breaks can mount up quickly, but it's worth considering in conjunction with maxing out an IRA if your employer's 401(k) doesn’t work for you.
Assume you're 45 years old and can save $12,000 each year for retirement. If you're unhappy with your 401(k), you may put $6,000 into an IRA and another $6,000 into a standard brokerage account, where it would remain untouched until you're ready to retire.
While it's convenient to be able to save for retirement in a 401(k), it's not necessarily the best option. If your company's 401(k) isn't a great plan, don't be afraid to put your money elsewhere.
