Key Points
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While 401(k)s can be convenient, they do have some serious drawbacks.
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You may be looking at limited investment choices and high fees.
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There’s also the issue of facing a penalty for taking an early withdrawal.
If you’re going to save money for retirement (which, to be clear, you should), then you probably want to do it in the most seamless, painless way possible. And that could mean falling back on your workplace 401(k).
Saving in a 401(k) is just about as easy as it gets. You tell your employer how much money you want to contribute out of each paycheck, and boom — that money lands in your retirement account, without you having to do a thing.
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Plus, if you’re lucky, your employer might offer a pretty generous 401(k) match. That free cash could get you closer to your long-term savings goals.
But while there are plenty of benefits to saving for retirement in a 401(k), these plans aren’t perfect. Here are some pretty big issue with 401(k)s all savers should be aware of.
1. The investment choices can be limited
You should care about how your retirement savings are invested. The more choices you get, the more likely you may be to meet your goals.
The problem with 401(k)s is that they tend to offer a limited mix of funds for you to choose from. That could prove problematic if your plan’s choices don’t really align with your preferences.
Remember, IRAs let you choose individual stocks to put your money into. That could help you chase higher returns and enjoy more diversification.
With a 401(k)s, you risk getting pigeonholed into funds that aren’t necessarily the best fit for you. And seeing as how it’s your money on the line, that’s a problem.
2. The fees can be high
With a 401(k), you’re generally looking at a couple of different types of fees. First, there are administrative fees, which cover the ongoing management of your plan. Then there are investment fees, which you can control to some degree by opting for low-cost index funds over more expensive mutual funds, but are a potential problem nonetheless.
With an IRA, you may be looking at fewer fees. That, coupled with more investment choices, could lead to more substantial growth.
3. There can be penalties for early withdrawals
Early withdrawal penalties aren’t limited to 401(k)s. You’ll also find them in IRAs. But either way, they’re something to keep on your radar, because the last thing you want is to lose a chunk of money in the course of tapping your savings.
Specifically, with 401(k)s and IRAs, there’s a 10% penalty to worry about if you take a withdrawal before turning 59 1/2. And while you may not have plans to retire early at this point in time, you never know what you’ll want to do in the future.
Also, sometimes people have to retire early, not by choice. If your industry crumbles, you may find yourself out of a job at 53 or 54, requiring you to tap your long-term savings until Social Security kicks in.
This isn’t to say that you shouldn’t put any money in a tax-advantaged account that imposes early withdrawal penalties. Rather, you should be aware that they exist and plan around them — perhaps by putting a portion of your long-term savings into a taxable account.
Be careful about how you save for retirement
There’s absolutely nothing wrong with using a 401(k) for your retirement savings. Quite the contrary — you should absolutely take advantage of your employer’s 401(k) if there’s a workplace match involved.
Just be aware of these key problems, and have a plan for addressing them. That plan could be choosing your 401(k) investments carefully and branching out to other accounts so you have options later in life.
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