3 Reasons Keeping All of Your Retirement Savings in a 401(k) Is a Huge Mistake

There’s a reason so many people like saving for retirement in a 401(k) plan. It’s easy to contribute to, since the money comes right out of your paycheck, and there’s often an employer match to sweeten the deal.

While a 401(k) could be a good home for some of your retirement savings, you probably don’t want to keep all of your money in a 401(k). Here’s why.

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1. Limited investment choices could be a problem

With an IRA, you can hold a variety of stocks or ETFs in your account. With a 401(k), you may be limited to a few dozen funds that don’t necessarily align with your investment choices.

Some of those funds might also come with costly fees, called expense ratios, that eat into your returns. You can do your due diligence and identify lower-cost index funds to keep your fees down. But ultimately, your investment options will probably be limited compared to an IRA.

2. You’ll be penalized for withdrawals taken before age 59 1/2

With a traditional 401(k), you get a tax break on contributions. As a result, you’re not allowed to withdraw funds ahead of age 59 1/2.

If you take an early withdrawal, you could face a 10% penalty. And the same rule applies to IRAs, for the record.

If you end up in a position where you want or have to retire early, that restriction could be a problem. So it pays to keep some of your retirement savings in a taxable brokerage account that lets you take withdrawals whenever you want.

3. You’ll have RMDs to worry about later

The IRS eventually wants to tax you on your 401(k) contributions. To that end, you’ll face required minimum distributions (RMDs) once you turn 73 or 75, depending on your year of birth.

RMDs aren’t always a problem. If yours are small, they may not raise your taxes that much. And if they represent funds you want to withdraw anyway, they’re not a big deal.

Issues tend to arise when you have a large 401(k) balance, your RMDs are substantial, and you don’t need the money. In that case, they can drive up your taxes, cause you to owe taxes on your Social Security benefits, and cost you more in the form of Medicare premium surcharges known as income-related monthly adjustment amounts.

That’s another reason to limit the amount of savings you keep in a 401(k). If you split your savings between a workplace plan and a taxable brokerage account, the latter portion of your nest egg won’t be subject to RMDs and the taxes that come with them.

Taking advantage of a 401(k) is a great way to grow retirement wealth. But you may not want to keep every dollar you’re saving for retirement in one of these accounts. Branching out could give you more investment choices and greater flexibility.

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