Many people invest in their 401(k) by default if their employer offers one. It may seem like the simplest option to sign up for this workplace retirement plan and build your nest egg through contributions from your paycheck.
But while it always makes sense to invest enough money to a 401(k) to earn any matching contributions employers make, workers should be aware that a 401(k) account may not be the best retirement investment plan for the rest of their savings.
In fact, there are three good reasons this account may not be the right one to use for the bulk of your retirement contributions after putting away enough to earn your full match. Here’s what they are.
1. Some 401(k)s charge high fees
For most people, 401(k)s offer a dozen or fewer investments.
In some cases, these investments are affordable index funds designed to track the performance of market indexes such as the S&P 500. But, for others, their options may be limited to expensive mutual funds or target date funds that charge high fees. Some 401(k) accounts also charge high account administrative fees as well, which must be paid on top of any investment costs.
If your 401(k)’s investment options are expensive, you could end up earning significantly lower effective returns than you’d be able to get if you instead invested in an IRA with a brokerage account that offers access to more affordable investments.
2. 401(k)s offer limited investment options
Even if you’re happy with the fees charged on the investments in your 401(k), the fact is that you’re still very limited in where you can put your money.
You can’t buy individual stocks, for example. And you may not have access to ETFs that offer exposure to more niche investments, such as cannabis or cryptocurrency-related exchange-traded funds.
If you want more control over your investments or you hope for a chance to beat the stock market by picking assets wisely after doing your research, a 401(k) account isn’t the ideal option for you. Instead, an IRA offering more flexibility could be a better place for retirement account contributions you make after maxing out your 401(k) match.
3. Retirees who invest in 401(k)s must take required minimum distributions
Finally, there’s another big downside of 401(k)s that you’ll face as a retiree. When you reach age 72, you’ll have to start taking Required Minimum Distributions (RMDs). RMDs are mandatory distributions based on IRS life expectancy tables.
The problem is, RMD requirements deprive you of the flexibility you may want when deciding how to spend your retirement funds. And they also could result in a huge increase in your taxes. You’ll obviously have to pay taxes on your withdrawals. And being forced to take minimum distributions could end up meaning you get pushed into a higher tax bracket and potentially render some of your Social Security benefits taxable as well.
Roth IRA accounts that don’t require RMDs allow you to avoid this 401(k) downside and may also be worth considering for the bulk of your retirement money once your 401(k) match is maxed out.
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