Is Your 401(k) Worth It?

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Updated on Thursday, December 10, 2020

401(k) plans are an easy and effective way to build a nest egg for retirement, and in most cases, it’s a smart financial move.

401(k) plans are offered to about 65% of U.S. employees, according to the annual Transamerica retirement survey released in August 2018. Typically a set amount (determined by you up to an annual federal limit) is automatically deducted from your paycheck on a regular basis and invested into a portfolio made up of stocks, bonds and other investment options. It’s a simple way to save for your future and potentially grow your wealth until you need it in retirement.

In most cases, a 401(k) plan is a solid option for long-term savings; however, there may be times when investing in your employer’s 401(k) is not your best move.

Here are eight times you may want to consider options beyond your company’s 401(k) plan.

8 signs your 401(k) isn’t worth it

1.  Your employer doesn’t match contributions

Many employers (up to 85%) who offer 401(k) plans offer some form of matching contributions. It’s up to the employer to determine the type of matching incentive program they will offer, which may be made up of cash and/or shares of company stock. For example, one employer may offer to match 50 cents on every dollar you contribute — up to a certain percentage of your salary — while other employers may match your contributions dollar-for-dollar. As an added bonus, these contributions don’t get calculated into your annual 401(k) contribution limit. However, you’ll get nothing if you don’t contribute to your 401(k), which essentially means you’re walking away from money.

If, on the other hand, your employer doesn’t offer matching funds, then you essentially have nothing to lose by exploring alternative options such as individual retirement accounts (IRAs) and other investment tools that may provide more flexibility with similar tax benefits. The 401(k) plan may still come out on top, especially when it comes to convenience, but do your due diligence to ensure you’re maximizing your money.

2. You’re not immediately eligible to participate

Employers aren’t required to offer retirement plans to employees, but if they do, they must offer them to all employees (part-time employees may be exempt). They may, however, set stipulations requiring you to be at least 21 years of age, and that you work a set period of time (such as one year) before you can enroll.

If participation in your employer’s plan isn’t an option for you for either of these reasons, you may want to explore other investment options. Then, when you’re eligible to participate in your employer’s plan, you can shift your investment dollars there, or even better, contribute to both. Note, however, that there may only be certain windows during the year when you can begin contributing, even after you’re eligible.

3. There’s a long vesting schedule

Any funds you contribute to your 401(k) plan are yours no matter what. While you may have to pay penalties for an early withdrawal (before the age of 59 and a half), it’s not always that cut-and-dry. In some cases, those shares must vest over time before they are considered “yours” to keep.

For example, if your company offers matching contributions that vest 25% each year, that means they won’t fully be yours for four years. If you leave your job after one full year, you’re eligible to take 25% of the matching contributions, and after two years, 50%. If you leave before a full year, you don’t get to take any of those contributions.

It may not make financial sense to invest in your company’s 401(k) if they have a long vesting schedule and you don’t plan to stay there long.

4. The investment options are limited

When you enroll in a 401(k) plan, you are presented with various options on how you can invest your money. These options may include mutual funds, stocks, bonds and variable annuities, among others.

According to the Financial Industry Regulatory Authority, the average number of available options falls between eight and 12, but the range is wide, with some employers offering just a few and others offering dozens. If your plan’s offerings are on the lower end, you may want to consider other ways to save for your future to better diversify your investments.

Some companies will automatically enroll you in their company’s 401(k) plan, with default investments and a set contribution amount selected for you. It’s up to you to change them if you want to specifically choose your investments.

5. Your 401(k) comes with high fees

All that potential for growth isn’t usually free, and a fee may be charged for managing your 401(k) plan. Your employer is required to provide you with a fee disclosure statement each year, but it’s easy to dismiss if it’s just a small percentage. However, that seemingly low fee can add up to a big loss for you over time, especially if you’re maxing out your 401(k) each year. This fee calculator from AHC Advisors can show how even a small percent of your investment can really add up over time. If the fee is too high, you may be better off exploring other investment options.

6. You’re maxing out contributions

No matter what your annual salary may be, there’s a maximum amount you can contribute to a 401(k) plan. The limit is $19,500 for the 2021 tax year, but it’s adjusted each year. If you’re over the age of 50, there are allowances for “catch-up” contributions, increasing your contribution limit to $26,000.

If you’ve hit your limit, but still want to sock more money away for your future, there are plenty of alternatives to consider. For example, IRAs often provide more flexibility, without penalties, for early withdrawals if you use the funds for certain things, such as buying your first home or for education expenses.

7. You’re swimming in debt

Compound interest is a beautiful thing if it’s working for you. In the case of debt, however, compound interest is working against you, which can dig you into a deep financial hole.

MagnifyMoney’s Credit Card Payoff Calculator can give you a good idea just how hard it can be to dig yourself out of debt when interest is working against you. For example, if you owe $10,000 on a credit card with a 21% APR and pay just $200 a month, you’ll end up paying almost $14,000 (over 120 months) in interest alone! That’s money that could be growing and earning interest for you if you wiped out that debt.

So, if you have a lot of high-interest debt, it may make sense to pay it off before investing. In many cases, you can work out a plan to do both simultaneously, but that will largely depend on your individual financial situation, including the amount and type of debt you’re carrying and your income.

8. You want to pay taxes now and take tax-free distributions in retirement

There’s no way to avoid paying taxes, but you can choose when you want to pay taxes on your contributions.

With a traditional 401(k) plan, taxes on the money you contribute are deferred until retirement. That means the full amount of your contribution can grow over the years, but will you have a tax bill to pay when you withdraw the funds in retirement.

Some employers may also offer a Roth 401(k). This option allows you to pay taxes on the money up front, allowing you to withdraw them tax-free later. However, any employer matching funds must go into a traditional 401(k), so you may have both plan types if you select the Roth option.

If your employer doesn’t offer a Roth option, you can always open a Roth IRA; however, there are income limits with Roth IRAs.

In general, Roth IRAs and Roth 401(k)s are beneficial for those in a lower tax bracket now, and expect to be in a higher tax bracket when they retire.

Bottom line

So, whether you’re already enrolled in your company’s 401(k) plan or will be facing an enrollment decision in the near future, make sure to use the above list to help make an informed investment decision.

Always review accompanying financial paperwork and seek professional guidance if you aren’t sure which is the best choice for you.

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