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3 Drawbacks of Using Only a 401(k) for Retirement

By Maurie Backman - Jul 2, 2021 at 5:04AM

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By itself, it might not be enough for your retirement. Here's what you need to know.

There are plenty of benefits to saving for retirement in a 401(k) plan. Not only does it offer much higher annual contribution limits than IRAs, but many companies that sponsor them also offer matching contributions. This means that if you put money into your plan out of your own paycheck, your employer might kick in some money as well. 

But while it pays to take advantage of a 401(k) if you have access to one, you shouldn't necessarily limit yourself to a 401(k). Here are three pitfalls you might encounter if you go that route.

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1. You can't pick individual stocks

Choosing individual stocks to invest in for retirement could not only help you grow more wealth, but could also help you assemble an investment mix that aligns well with your strategy, risk tolerance profile, and goals. But 401(k) plans generally don't let you buy individual stocks.

Rather, 401(k)s allow you to invest in different funds. Some of those funds may be actively managed, which means you'll pay higher investment fees (known as expense ratios). Your 401(k) might also offer a bunch of passively managed funds, known as index funds, which come with much lower fees but might not allow you to invest the way you want to.

Whether you put money into an actively managed mutual fund or an index fund, either way, you get no say in the specific stocks you own. IRAs, on the other hand, do allow you to add individual stocks, so you may want to open one on top of a 401(k).

2. You might get stuck with hefty fees

Not only might you pay investment fees with a 401(k), but you could get stuck with costly administrative fees that eat away at your returns. IRAs, by contrast, tend to charge lower administrative fees (though this isn't always the case).

Now the good news is that 401(k) plan administrators are required to disclose their fees up front. And if you find that they're high, you can talk to your employer about potentially switching retirement plan providers. But those fees are something you'll need to be aware of.

3. You may not get a Roth savings option

Though 401(k) plans are increasingly offering Roth savings options, not every 401(k) has one. With a Roth 401(k), your contributions don't go in on a pre-tax basis, but once you fund your account, your money gets to grow completely tax-free and you get to take your withdrawals tax-free during retirement.

A Roth 401(k) is a smart savings option if you expect your tax rate to be higher in retirement than it is today, or if you simply want to lower your tax burden later in life. By contrast, Roth IRAs are widely available, and while you may not be able to contribute to one directly if you earn too much money, you can always fund a traditional IRA and convert it to a Roth afterward.

While it certainly pays to take advantage of your employer's 401(k) -- especially if there are matching funds involved -- you may not want to stick with that plan alone. In addition to opening an IRA on top of your 401(k), you may want to explore other options, like funding a health savings account (which can function as a retirement savings tool) or even a traditional brokerage account. That way, you can really set yourself up with enough money to cover all of your senior expenses.

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