Why 401 (K) May Not Be Enough for Retirement (and What Else to Do)
While 401 (k) plans are often viewed as a set and forget investment account, they are not always guaranteed to cover all retirement costs. With contribution limits, fees, taxes and mandatory withdrawals, 401 (k) s do have their limits. This is why investing in other types of investments will ensure that you achieve your retirement goals.
Why 401 (k) s might not be enough
First, 401 (k) s are still a great way to save up for retirement, especially if an employer is willing to match your contributions. Finding an employer dramatically accelerates the growth of your savings through compounding interest , which can make up the bulk of your retirement savings. However, 401 (k) s have disadvantages as well.
401 (k) contributions capped
If you are under 50, your maximum contribution is capped at $ 19,500 (or $ 26,000 for those over 50). There is also a total contribution cap of $ 58,000 in 2021, which includes your employer’s contributions. While this may seem like a high enough cap, limited contributions make it difficult to catch up on your retirement savings for years when you either didn’t have a 401 (k) plan yet or didn’t make any contributions (as is the case with many people in their twenties ).
Taxes, inflation and fees
Contributions for 401 (k) s are tax deductible until you withdraw them later on retirement, but there is no guarantee the tax rate will stay low when you are ready to retire. Likewise, although stocks and long-term bonds have a long history of outstripping inflation, this margin can unexpectedly contract and shrink to the expected value of your retirement fund. Also, many 401 (k) have expensive 1-2% fees. As Investopedia points out , if a fund grows 7% in a year, but charges an annual fee of 2%, you are left with 5%.
Lack of liquidity with the subsequent mandatory withdrawal of funds
With 401 (k) s, you’re forced to follow a strict schedule that doesn’t give you much flexibility in how you can use your funds for most of your life. If you don’t want to pay taxes and a 10% early withdrawal penalty, you cannot take money from 401 (k) until you are 59.5 years old. Then, at age 72, you are forced to withdraw thousands of dollars in a mandatory manner known as mandatory minimum payments (the amount is based on a sliding scale that increases with age ). Again, if you don’t have all the savings you need, these allocations can easily put off your retirement plans.
Consider diversifying your investment
While 401 (k) still offers a lot of value, consider using a financial planner to help you diversify other investments like real estate or other investment vehicles like the Roth IRA. Unlike 401 (k) s, Roth IRAs are taxed upfront, which means you don’t have to deal with tax uncertainties and mandatory withdrawals later on in retirement. With both a Roth IRA and a 401 (k), you protect yourself from potential pension fund shortages that could hit you later in life when you need money most.