3 disadvantages of only using a 401 (k) for retirement
Not all 401 (k) are created equal, and using the wrong one to save for your retirement could make your job that much harder. Different types of retirement accounts have different strengths and weaknesses, so it’s helpful to have more than one. Here’s a closer look at some of the ways you could go wrong if you’re just using a 401 (k).
1. You probably won’t have as many investment options
A 401 (k) usually lets you choose from a handful of mutual funds selected by your employer, and sometimes that’s just fine. But if there aren’t any options you’re interested in, there’s not much you can do. Your employer might be willing to add other investment choices if you ask, but it’s not required.
Without another retirement account, you could end up with investments that don’t match your risk tolerance or that don’t have a good rate of return. At best, it could force you to wait longer to retire, and at worst, it could threaten your financial security in your old age.
If you don’t like your investment choices, consider opening an IRA and putting some of your retirement savings into it. IRAs allow you to invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), and a lot of other things. This gives you more control over your portfolio and you could earn more over time if you choose the right investments.
Remember, you are only allowed to contribute $ 6,000 per year to an IRA in 2020 and 2021 or $ 7,000 if you are 50 or older. So if you start saving in any of these accounts, you may need to revert to your 401 (k) after you hit your contribution limit.
2. You might pay higher fees
Another downside to limited investment options is that there is less you can do to lower your costs. It is always a good practice with any retirement account to understand what you are paying annually and to check back periodically to see if there are more affordable investments that would be right for you. You can do this by viewing your plan summary or prospectus. But if your business doesn’t offer a lot of other investment options, you might be forced to pay the fees you currently have.
Fees reduce your profits, forcing you to save longer before you can afford to retire. While every plan is different, many 401 (k) charge higher fees than IRAs, so putting money into an IRA and choosing low-cost investments like index funds could help you grow. your wealth faster than just using your 401 (k).
Of course, you must weigh the value of any 401 (k) employer correspondence you receive. This is something you can’t get with an IRA, so if your business match covers what you pay in fees, it’s worth contributing at least enough to get that match every year. Then you can switch to an IRA if you want to save even more.
3. You could end up paying more taxes
Most 401 (k) are tax-deferred, which means your contributions reduce your taxable income this year, and then you pay taxes on your distributions later. These accounts are ideal for those who think they are making more money now than they will spend each year in retirement. By deferring taxes until retirement, when you are hopefully in a lower tax bracket, you will be paying the government a smaller percentage of your savings.
But if you think you’re earning about as much or less than what you’ll spend in retirement, a traditional 401 (k) could end up costing you more. You’d better save on a Roth 401 (k) if your business offers one. They work the other way around: you pay taxes on your contributions this year so that you can enjoy tax-free withdrawals in retirement.
While Roth 401 (k) are more and more common, not all companies offer them. If not, consider a Roth IRA instead. The government taxes them in the same way as Roth 401 (k), although you can only contribute up to $ 6,000 per year or $ 7,000 if you’re 50 or older. If you exceed this threshold, you can always revert to your regular 401 (k). It might not give you the best tax benefits, but it’s something nonetheless.
My goal here is not to scare you off 401 (k) but to help you understand if a 401 (k) is the best place for your savings. If you haven’t thought about how your current income compares to your projected retirement income, or if you haven’t considered your investment options and associated fees in the past year, do so. now. If you’re happy with your 401 (k) that’s great, but if not, consider putting some of your savings into another account, like an IRA, to make up for some of your 401 (k) shortcomings.