A 401(k) plan is by far the most popular retirement account, and for a good reason. It's offered through employers, it's convenient, and it's hands-off for the most part -- a triple win for most people. For tax year 2023, the maximum contribution someone can make to a 401(k) plan is $22,500 ($30,000 if you're 50 or older), an increase of $2,000 and $3,000, respectively.

While this increase means people can save more money for retirement, maxing out your 401(k) plan can be overrated. Here's why.

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Your investment options are limited

One downside of a 401(k) plan is that your investment options are limited because your plan provider presents you with your choices. These options usually consist of your company's stock (if it's a public company), market cap-based funds, and target-date funds. This could present a problem for investors who want more say in their investments.

A retirement account like a Roth IRA operates similarly to a regular brokerage account because you can invest in any stock you want: individual companies, index funds, mutual funds, and everything in between. This makes it easier to have investments that align directly with your investing strategy.

Whether you're a dividend investor, value investor, growth investor, or anything else, having set investment options might make it harder to stick to your strategy.

Fees can add up

Although there are many benefits to a 401(k), the plans are not without fees -- often costly ones. Most fees fall into one of three categories: administrative, investment, or services.

  • Administrative fees cover the day-to-day operation of your 401(k) plan, such as accounting, record keeping, legal services, and more.
  • Investment fees are generally the largest fees you'll face, and they're charged as a percentage of your account total.
  • Services fees are associated with any optional and additional features you might decide to add to your account.

With a Roth IRA, there are no fees to make a trade and no ongoing fees for maintaining an account. While you'll still pay expense ratios for any funds you invest in, they're usually much lower than what you'd pay with a 401(k) plan. 401(k) plan fees vary based on your employer's chosen plan (larger companies tend to have lower fees), but they can be up to 2%.

For perspective, if you contribute $1,000 monthly to your 401(k), averaging 8% annual returns over 20 years, a 2% fee would cost you more than $100,000 during that span. Add in another 10 years, and you're looking at more than $400,000 in fees.

Don't forget about Uncle Sam

Contributions to your 401(k) are generally pre-tax, which has the benefit of lowering your taxable income. This is a great benefit, but it doesn't let you off the hook; you'll have to pay taxes when you receive your distributions in retirement. This isn't the case with a Roth IRA, however.

With a Roth IRA, you contribute after-tax money, and in return, you can take tax-free withdrawals in retirement. If you're eligible to contribute to a Roth IRA -- single filers earning less than $138,000 and married couples filing jointly earning less than $218,000 -- you should do so. Having your money grow and compound tax-free can easily save you tens of thousands of dollars.

Even if you won't always be eligible to contribute to a Roth IRA, doing so while you can and letting time work its magic can work wonders.

Overrated doesn't mean bad

Although maxing out your 401(k) plan can be overrated, that doesn't make it inherently bad. Anytime you're saving and investing for retirement is good. But if you don't have the means to max out both your 401(k) and a Roth IRA (and most people don't), you should consider approaching retirement savings as follows:

  1. Contribute enough to your 401(k) plan to get your full employer match if they offer one.
  2. Max out your Roth IRA contributions ($6,500 annually in 2023; $7,500 if 50 or older).
  3. Return to your 401(k) and increase your contributions accordingly.

There's no one-method-fits-all when it comes to saving for retirement, but the above suggestions can help you get the best of both worlds. You can lower your taxable income and get "free" money with an employer match using your 401(k), and you can take advantage of tax-free compounded earnings in retirement with a Roth IRA.