Making the most of your 401(k) can be a great retirement accomplishment. In 2023, it means investing $22,500 (or $30,000 if you are over 50) for your future. This can easily grow into hundreds of thousands of dollars after being invested wisely for several decades. But that doesn’t necessarily mean you should.
Although 401(k)s have many benefits, they also have drawbacks. If any of the four things listed below are a big issue for you, you may want to look for another retirement account to store your cash.
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401(k) limits investment choices
Your 401(k) plan provider determines what you can invest your 401(k) funds in. Often, it will be a combination of index funds and target date funds. The idea is to make things very simple for people who don’t know much about investing. But that’s not what everyone wants.
Those who want to invest in specific stocks may prefer to keep their cash in an IRA where they can invest the funds. An IRA gives you additional flexibility to invest how you want and change your investment strategy as needed.
If your 401(k) primarily offers funds with high expense ratios, an IRA may be a better choice. These are annual fees charged as a percentage of assets and paid to the fund manager by everyone who invests in the fund. You can find out how much fees you are paying by checking the prospectus. Ideally, this should be kept below 1% whenever possible.
401(k) may not give you a choice in when to pay taxes
Most 401(k)s are tax deferred. This means you can get a tax deduction in the year you donate and pay the taxes you withdraw later. This is suitable for people who think their taxes will be lower in retirement than they are now. But that’s not necessarily desirable for people who think they’ll be in the same or higher tax bracket in retirement.
These people may be better off using a Roth IRA. Roth 401(k)s also exist, but they are less common. If you’re lucky enough to have it, this could be a better option if you want to withdraw your retirement funds tax-free.
401(k) limits withdrawals
Once you put money into your 401(k), you usually can’t take it out again until you’re 59 1/2 years old. If you do this without a valid reason, such as large medical or educational expenses, you will be subject to a 10% early withdrawal penalty.
This also applies to traditional IRAs. Roth accounts are a little more flexible, allowing you to withdraw contributions at any age without penalty, but there are still penalties for early earnings withdrawals.
People who want to retire by age 59 1/2 may prefer to leave some funds in a taxable brokerage account. These don’t have the same tax benefits as retirement accounts, but there are no restrictions on how much you can contribute or when you can access your funds.
401(k) contribution limits are high
Getting the most out of your 401(k) can be quite difficult. In 2023 he will need to set aside $22,500, or if he is over 50 he will have $30,000. In 2024, these limits increase to $23,000 and $30,500, respectively. Most people don’t have that kind of cash on hand.
But you don’t have to max out your 401(k) every year, or any year, to have a comfortable retirement. Whether it’s a 401(k), IRA, or other account, the money you set aside for your future will serve you well in the long run.
If you don’t think a 401(k) is the right choice for you, that’s okay. Start with a traditional or Roth IRA. Once you max it out, you can always go back to your 401(k) for the rest of the year or try a non-traditional retirement account like an HSA.
