The U.S. Census reports that among working-age Americans aged 15 to 64, the most common type of retirement account used in 2020 was a 401(k) plan, or a comparable plan like a 403(b). In fact, a good 34.6% of savers had one of these accounts, compared to just 18.2% who had an IRA.
Now there are certainly some benefits to making a 401(k) your retirement savings plan of choice. For one thing, 401(k)s often open the door to employer matching dollars that can help you grow your balance. They also get funded automatically from payroll deductions, which can help you stay on track with your contributions.
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As such, if you have access to a 401(k) plan through your job, you may want to sign up for it sooner rather than later. But you probably also don't want your 401(k) to be your only retirement savings plan. Here's why.
1. Your investment choices might be limited
With an IRA, you get the option to load up on individual stocks in your portfolio. Not so with a 401(k). Generally, with a 401(k) plan, you're limited to a bunch of different funds, from mutual funds to index funds. You can also opt for a target date fund, which will adjust your asset allocation depending on how far away from retirement you are.
One problem with not getting to choose individual stocks, though, is that you have limited say over how your retirement plan is invested. So it could pay to open an IRA on top of a 401(k) so you get that choice.
2. Your fees might be high
While index funds tend to be a low-cost option for retirement savers, and you'll often find those in a 401(k), some of the other funds you'll find in an employer retirement plan may come with hefty fees. Target date funds and mutual funds both fall into this category.
High fees can eat away at your nest egg's returns over time, leaving you with less money when you get to retirement. Plus, with a 401(k), you might pay a host of administrative fees regardless of the specific investments you choose. With an IRA, those fees might be lower.
3. You might face penalties if you access that money in the course of retiring early
Some people aim to retire in their 60s. But what if you want to make your workforce exit in your early or mid-50s because you've saved well?
With a 401(k), you may have a problem. Generally, you'll be penalized 10% on 401(k) plan withdrawals taken prior to age 59 1/2. So if you want to retire at, say, 54, and you have all of your money in a 401(k), you'll be in a tough spot.
Unfortunately, branching out into an IRA won't help in this regard. IRAs, too, penalize you 10% for removing funds before age 59 1/2, generally speaking.
If you want to keep the option of early retirement on the table, keep some of your long-term savings in a regular brokerage account. You'll forgo the tax benefits that come with funding an IRA or 401(k), but you'll gain in the form of more flexibility with your money. Taxable brokerage accounts allow you to take withdrawals at any time without penalties coming into the mix.
Saving for retirement in a 401(k) plan could end up being a smart move. But you may not want to make a 401(k) your only retirement savings plan. Branching out into other accounts could make it so you get more investment choices, pay lower fees all in, and get access to your money when you want it.
