Biggest 401 (K) S Complaints
Saving up for retirement is a lot like going to the dentist. We all know we have to do this, but putting it off is easy because it’s painful and boring. As daunting as the investment is, 401 (k) is a great start and a great savings motivator . However, 401 (k) is far from perfect.
First, despite common complaints about 401 (k) s, if your employer offers it, you should sign up for it . Many employers offer a match , which means they will match a percentage of everything you save in your 401 (k) plan, up to a certain point. This is free money, so you want to take as much of it as possible. In other words, you want to save enough to get the best match. They may not be perfect, but they are better than nothing, and for many they are an alternative.
The fees are too high
Perhaps the biggest complaint about 401 (k) s is that they come with expensive fees. In the investment world, these fees are called expense ratios . The expense ratio is the operating cost of an investment and is measured as a percentage of the investment. Firms like Vanguard and Fidelity charge less than 0.10% on many of their investments. On the other hand, 401 (k) s often have expense ratios as high as 1.5 percent.
The problem is that there is nothing you can do about 401 (k) fees because you only get that kind of control over the investment you choose. “But a negligible percentage? Nothing of the kind, ”you say. “What’s the matter, curmudgeon?”
You’re right. This is a small percentage. Tiny! Over time, however, 1.5% can add up to a significant amount. Let’s say you invest $ 100,000 and get a seven percent return over 20 years. With a commission of 1.5%, you will receive $ 291,000. Not bad. But with a commission of just 0.10%, the same investment would be $ 379,799. That’s a difference of over $ 88,000.
This is why so many investors hate 401 (k) s: out of control fees. You can use this investment commission calculator to compare expense ratios. And if you don’t know how high your 401 (k) expense ratio is, you can either look at it in your report or use a tool like FeeX to analyze your portfolio to help you figure it out.
This doesn’t mean you shouldn’t invest in your 401 (k) at all. Again, you want to save enough to get a match. After all, free money is a great deal, even with the commission.
However, once you’ve got the best you can out of this tutorial, it doesn’t make sense to save more on your 401 (k) . At this point, it probably makes sense to open your own Individual Retirement Account (IRA) and keep your money there in a set and forget long-term investment portfolio . This way you can buy a cheaper investment.
Your investment options are limited
When you spend more money on something like shoes or a mattress, you usually get better quality. Investments are not always the case.
A higher expense ratio is not a good indicator that your investment will bring more value than you might have chosen on your own . In fact, it’s a common complaint that 401 (k) funds are actually worse than the ones you might choose on your own . There is also the issue of the variety of types of funds and investments. Underlying stocks and bonds are a good place to start investing, but investing in other things is also a good idea , and most 401 (k) ones keep your eggs in just a few baskets. As Investopedia explains, they should be simple, not varied .
Look at your 401 (k) statement to find out which funds you have invested in. Tools like Personal Capital and Mint Investments can also help you figure this out. Personal Capital will tell you which investments you own versus which investments you should own based on your age and risk tolerance. Once you figure out what your portfolio should look like, you should check out the 401 (k) options to see if any comparable investments are available. For example, if Personal Capital offers more international stocks, you can see if your 401 (k) is offering an international stock fund. If this is not the case, you can use the IRA to purchase the required investments.
This “free money” is not entirely free
It’s nice for your employer to suggest a 401 (k) match, but it’s not entirely altruistic. Companies offering matching employers often pay lower wages, according to the Center for Pension Research . This is especially true for workers with higher incomes (top 40% of the income distribution). In its report, the Center for Pension Research writes:
… among male workers, an additional 401 (k) employer contribution dollar replaces 90 cents in wages for those with high incomes, and only 29 cents for those with low incomes … Among working women, an additional 401 employer dollar ( k) Contributions replace 99 cents in wages for high-income people and only 11 cents for low-income people. These results support the notion that the relationship between fringe benefits and wages may differ for workers at different income levels. For high-income workers, the 401 (k) extra contributions are almost entirely offset by lower wages.
In addition, as noted former hedge fund manager and author James Altucher , you should also be fully ensured in order to get money. Employers don’t just put all your money in at once. They sit on it and distribute the allowance over the years, up to six years in total. In other words, you may have to work for six years or that “free” money will go away.
You cannot choose your tax advantage
Any retirement plan has a tax advantage, but there are two specific types of benefits. Some retirement plans, such as traditional IRAs, are not tax deductible. This usually means that you can deduct the amount saved from income tax. In other words, you will now pay less taxes, which is great if you need to save now. You will still pay taxes on the amount you save (Uncle Sam wants his money, after all), but you will pay it when you withdraw your cash, presumably when you retire.
Other retirement plans, namely the Roth IRA, do not offer this benefit. Instead, they offer tax-free growth, which basically means you now pay taxes as usual, but you pay nothing when you withdraw your money at retirement. The money you make from your investments grows tax-free. It’s a pretty good deal and most experts recommend Roth for tax-free growth.
With a 401 (k), you have a tax advantage, but this is usually a tax deferred option. While Roth 401 (k) s are becoming more common , in many cases, you cannot choose, you have to put your savings aside, and you have to pay taxes on the road. In other words, when you withdraw money in your 401 (k) plan, you must pay taxes. Don’t get me wrong, tax advantage is still good, but this is another 401 (k) complaint: you can’t always choose your tax advantage.
However, if you want to balance things out, you can open a Roth IRA in addition to your 401 (k). We’ve already told you that opening an IRA to diversify your portfolio and avoid crazy high fees is a good idea, so you can also opt for a Roth IRA to fully benefit from tax-free growth.
Again, 401 (ks) are useful for a quick start to retirement savings. They motivate many people who would not otherwise think about investing to start saving money for their future. They also make investing easier. However, there is a trade-off for this simplicity. When you know what you are dealing with, you know how to work around its shortcomings and limitations.