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When It Makes Sense to Opt Out of Your 401(k)

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401KIt’s considered a no-brainer by many: Participate in your employer’s 401(k) plan. In fact, due to recent legislation, many employers automatically enroll their workers in 401(k) plans. This enrollment, though, doesn’t guarantee that workers won’t opt out. And, in some cases, it make actually make sense to opt out.

Just because your company has a 401(k) doesn’t mean that it’s the right choice for you. Before you just blindly participate in your company’s 401(k), make sure that it makes sense. You don’t want to end up with a retirement account that doesn’t help you maximize your money. Here are some indications that your company 401(k) may not be the best choice for you:

  • No company match: Many companies will match your contributions to a certain point. However, if your company doesn’t provide a match, it better have some other great features that make up for it.
  • High plan fees: Some company 401(k)s feature high plan fees. You might pay high administrative costs, or there might be a buy-in. The funds chosen by some companies might come with high management fees and even sales loads, that eat away at your returns.
  • Limited investment choices: In some cases, you might not have many investment choices when it comes to your company 401(k). Without the option to choose something that works for you, you might end up in a plan that doesn’t adequately help you reach your goals. Another problem might be that your plan is too heavily invested in company stock. Do you really want your future to be tied too closely to the fate of your company’s stock?

In some cases, you might be better off opting out of your company’s 401(k) and instead investing on your own. You could open an IRA, and have access to lower cost options — and a variety of investment choices. This is especially true if you don’t have the ability to max out your 401(k). One of the advantages to a 401(k) is that your contribution limits are higher. If you won’t contribute more than the IRA limit, though, that advantage disappears.

Of course, it doesn’t have to be either-or. You can also combine your efforts. If your employer offers a match, but you don’t like your investment options, you can do what is necessary to earn the maximum match, and then open an IRA to handle the rest of your retirement contributions. It’s perfectly alright to spread your contributions around between accounts — especially if your employer’s 401(k) is lacking.

In some cases, the costs associated with an employer’s plan can be so high that you are better off investing elsewhere, even if you aren’t using a tax-advantaged plan. Run the numbers and consider the costs (including the costs that can arise from having an incompetent plan manager at the helm of your retirement account). It goes against most financial conventional wisdom, but sometimes it actually makes sense to opt out of your company’s 401(k). Just make sure you have an alternative plan for funding your retirement if you decide that opting out is your best choice.

(Photo: mujitra)

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10 Responses to “When It Makes Sense to Opt Out of Your 401(k)”

  1. billsnider says:

    I use to work for a small business. They had a 401(k) plan. Unfortunatgly the fees were between 3-4% and it had no company match. This did not make sense to me so I did not participate.

    Bill Snider

  2. Britton says:

    Well said. It almost always works to follow the order of “401(k) up to match->max out IRA->max out 401(k)” when figuring out where to put your next retirement dollar. 401(k)’s are, sadly, notorious for high and opaque fees.

  3. uclalien says:

    As Bill Snider points out, it may not be beneficial to participate in your company’s 401k plan if your company does not match and investment management fees are high. With that said, contribution limits may be an important determining factor. If you want to invest more toward retirement than an IRA will allow, your company’s 401(k) can be a good place to stash any additional retirement funds, in spite of management fees.

  4. uclalien says:

    Miranda,
    I found the following paragraph is a bit confusing:

    “In some cases, you might be better off opting out of your company’s 401(k) and instead investing on your own. You could open an IRA, and have access to lower cost options — and a variety of investment choices. This is especially true if you don’t have the ability to max out your 401(k). One of the advantages to a 401(k) is that your contribution limits are higher. If you won’t contribute more than the IRA limit, though, that advantage disappears.”

    In the third sentence, did you mean to say “IRA,” rather than “401(k)”?

    Your first sentence seems to imply that a person might prefer an IRA over a 401(k). In this case, whether or not a person can fully fund his 401(k) is irrelevant when choosing whether or not he should contribute to an IRA. Any 401(k) contributions would come after an IRA was fully funded. On the other hand, whether or not a person can fully fund his IRA can be a determining factor when deciding to invest in his company’s 401(k) due to the lower contribution limit for IRAs.

    • Miranda says:

      Sorry for the confusion. I meant to convey that, if you are in an either-or position, and you aren’t going to be putting enough money in to max out an IRA anyway, and you don’t like your company’s 401(k), you might as well just go for the IRA. You can always contribute to the 401(k) later if you ever end up maxing out the IRA. So, yeah, I probably meant to say “IRA.”

  5. CB says:

    I’ve moved mine into money market fund to preserve it and have the max taken out because of the tax advantage. That not taxed amount is higher than any return from the 401k plan–losing money recently, not even standing still.

    I sm eligible to take it out without penalty because of my age.

  6. Steve says:

    I have contributed to 401(k)’s with “wrap” fees as high as 1.35% (that is on top of the underlying mutual funds’ fees). I got a tax deduction in the year I contributed, and then when I left after a couple years, I rolled it over into an IRA at a discount brokerage. Were the fees unreasonably high? Yes. Did it matter? Not really.

    If I had to face 3-4% fees, I might make a different choice. But fees that high are the exception, not the rule. Fees are usually closer to 1%.

  7. Anonymous says:

    Miranda I have a unmatched 401k and I max it out along with my Roth IRA and I have dividend stocks in my taxable accounts. I sometimes feel that I might be better off putting in less in the 401k and more in my taxable account because of the following:
    1. when I go to take out my 401k it will be taxed at a higher rate than the taxable accounts.
    2. I can’t buy dividend stocks like coca cola or Procter and Gamble in my 401k and even with the upfront tax break of the 401k, I fill that these two stocks will do better than my 401k mutual funds over 20 years and will be taxed at a lower rate when I start making withdrawls in retirement.

  8. Rob says:

    Miranda

    I forgot to leave my name on post about putting less in my 401k and more in my taxable accounts such as coca cola and PG.

    Thanks

    Rob

    • Rob says:

      My orginal post didn’t show up.

      Here it is.

      I max out my unmatched 401k and my roth ira and have dividend stocks in my taxable account.
      I feel that maxing out my 401k may not be the best idea because of the following:
      1. I feel stocks like coca cola and PG will do better than my 401k mutual funds after about 20 years even with the up front 401k tax break.

      2. When I go to withdrawl my money, the taxable stocks will be taxed at a lower rate than the 401k.


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