What to Do If Your 401(k) Is No Good
Many 401(k)s have a diverse selection of low-fee investment funds to choose from, but this isn't always the case. Some companies' retirement plans have just a few funds available, or their fund options have fees that are incredibly high. Here's how to know if your 401(k) is no good, and what to do if it is.
What makes a "bad" 401(k)?
In a nutshell, there are three things to look for to determine whether your 401(k) is good or not -- fees, investment selection, and employer match.
- Fees. According to one recent study, the typical 401(k) plan costs participants 0.67% of their assets annually -- so a $100,000 401(k) account would pay $670 in fees per year. And this varies significantly based on plan size -- in general, bigger plans have lower fees than smaller plans. Smaller companies' 401(k) plans with less than $10 million in assets have a median of 1.27% in fees, but it's not uncommon to find plans with fees in the 2% range or even higher.
Total Plan Assets
Median Annual Fees (% of Assets)
$1 million-$10 million
$10 million-$100 million
$100 million-$500 million
$500 million or more
Source: Deloitte Consulting/Investment Company Institute.
- Investment selection. A good 401(k) has a variety of funds to choose from, representing many different asset classes (stocks, bonds, money market). A severely limited selection of investments is a red flag that your plan isn't the best.
- Employer match. One of the biggest perks of investing in a 401(k) is that many employers will match a certain amount of contributions. For example, a common matching program is 100% of an employee's contributions up to 6% of their compensation. I won't go so far as to say that a plan without an employer match is bad, but investors could generally do just as well or better by investing in an IRA instead.
Also, keep in mind that just because one of these things applies to your 401(k) doesn't necessarily make it a bad plan. For example, if your investment selection is limited but the few funds you have to choose from are solid choices with low fees, it could still be a good 401(k).
Take advantage of your employer's match -- even if your 401(k) isn't great
Unless your 401(k) is ridiculously bad -- just a couple of funds or expense ratios in the 3%-5% range, for instance -- you should still contribute enough to take full advantage of your employer's matching contributions, unless there aren't any. After all, free money is free money, even if it's invested in a less-than-ideal situation. High fees, or a limited selection of investments is no reason to throw away an instant 50% or 100% return on your contributions.
... but don't contribute a penny more than you need to
If you decide that your 401(k) is bad, you're probably better off investing for your retirement in an IRA instead. As I mentioned, take advantage of your employer's matching contributions, if any, but don't put in any extra.
When it comes to IRAs, you have two basic choices -- traditional or Roth. A traditional IRA works just like most 401(k) plans, in the sense that contributions may be tax deductible, depending on your income and whether or not your employer offers a 401(k). Your investments grow and compound tax-deferred until retirement, at which point they can be withdrawn as taxable income.
On the other hand, a Roth IRA won't get you any immediate tax break. Contributions aren't deductible, but qualified withdrawals in retirement will be 100% tax-free. Here's a guide to the different types of IRAs to help you decide.
Once you contribute to an IRA, you have the ability to invest in any stocks, bonds, or funds you choose. If you want to buy stock in specific companies, you're free to do that. Or if you'd prefer to keep your retirement investing easy, you can shop around for funds , and probably get lower fees than are available in your 401(k).
The point is that as long as your eligible to contribute to an IRA and can take advantage of the tax benefits, these types of retirement accounts are much better places to put your retirement savings than a bad IRA.
The bottom line on bad 401(k)s
In most cases, a bad 401(k) is better than none at all, but you should look elsewhere for your retirement savings needs beyond the amount your employer is willing to match. If you like the "autopilot" style of retirement savings a 401(k) provides, you can invest in cheap index funds through an IRA that will allow you to do the same thing. Or, if you prefer a more active role, there are literally thousands of possible investments.
The bottom line is that if your 401(k) has a good selection and reasonable fees and you don't want to pick stocks or funds on your own (nothing wrong with this), then it's perfectly fine to use it as your only retirement savings vehicle. On the other hand, if you can get better-priced investments elsewhere, your 401(k) should be used to maximize your employer's contributions, but no more.
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