It used to be that if you worked for the same employer long enough, you'd retire with a pension that, combined with Social Security, would provide enough income to sustain you during your golden years. But pensions are pretty uncommon nowadays, as is sticking with the same employer for decades. As such, most workers have to take retirement savings into their own hands for a shot at financial security down the line.
Now you have several choices when it comes to building your nest egg. You could open an IRA through a number of financial institutions. But if your employer offers a 401(k), it generally pays to participate in it.
Still, 401(k) plans aren't perfect. Here are a few major issues with these plans.
1. Workers are responsible for learning how to invest
When you have a pension, it's on your employer to invest those funds to ensure that there's enough money to dish out retirement benefits down the line. When you have a 401(k), or an IRA for that matter, it's on you, the saver, to build a portfolio that generates ample growth without subjecting yourself to needless risk. That's a hard thing to do if you don't know a lot about investing.
In fact, many savers invest their 401(k)s too conservatively because they're afraid of losing money. Others go too heavy on stocks and expose their accounts to a dangerous level of volatility as retirement nears. In other words, 401(k) participants risk making bad choices with their hard-earned savings, and struggling financially during retirement as a result.
2. Investment choices are limited
When you save in an IRA, you get a wide range of investment options that include the opportunity to load up on individual stocks. That's a good thing if you're a more confident investor who knows how to vet different companies. With a 401(k), however, you're limited to a smaller number of investment options, and rather than buy individual stocks, you're given the choice to buy different funds. That can be a good thing with regard to instant diversification (which is something you want in your retirement portfolio), but it also limits your options and opportunities for growth.
3. Fees can be notoriously high
It costs money to administer a 401(k), and unfortunately, that expense is typically passed on to individual savers. Additionally, the investments you choose within your account come with fees as well, known as expense ratios. Generally speaking, actively managed mutual funds come with much higher expense ratios than index funds, which aren't actively managed, but rather, passively track existing indexes, like the S&P 500. But depending on your plan's investment choices, you may not have that many lower-cost index funds to pick from.
Should you participate in a 401(k)?
Despite these pretty glaring drawbacks, it generally still makes sense to participate in a 401(k) if that option is available to you. For one thing, 401(k)s comes with much higher annual contribution limits than IRAs. For 2019, workers under 50 can sock away up to $19,000, while those 50 and over can save up to $25,000. In 2020, these limits are increasing to $19,500 and $26,000, respectively. By contrast, IRAs only allow for $6,000 in annual contributions for workers under 50, and $7,000 for those 50 and over -- and these limits are staying in place for 2020.
Another positive about 401(k)s is that many of the employers that sponsor them also match worker contributions to varying degrees. This means that you could be looking at free money for retirement if you contribute enough from your earnings to snag that match.
The takeaway? Understand the drawbacks of 401(k)s and do your best to work around them. Review your investment choices carefully and pay attention to the fees they charge. And if you need help selecting your investments, ask for it. Your employer may be willing to set you and others in your situation up with a financial advisor who can offer some initial guidance.