Saving for retirement is tough, but it's more important than ever to have a robust nest egg. The average worker expects to need around $1.8 million to retire comfortably, according to a 2023 survey from Charles Schwab, and some people could need even more.
Contributing to a 401(k) is one of the simplest and most accessible ways to save, and in some cases, it can be your best option. But it won't be right for everyone, and there are a few reasons you might want to avoid this type of account.
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1. You may not have as many investment options
The 401(k) is one of the most restrictive types of accounts when it comes to choosing where you invest. Most plans offer a small variety of mutual funds to choose from, and if none of those funds meet your needs, you're stuck with them, anyway.
For some people, that's not necessarily a bad thing. But if you're looking to customize your portfolio by investing in index funds or individual stocks, for example, you generally can't do that with a 401(k).
This can also make it more challenging to earn above-average returns. Mutual funds aren't bad investments but often earn lower returns over time than other types of investments. If you're looking to maximize your long-term earnings, it can be difficult to do that with a 401(k).
2. You could face high fees
While all investment accounts charge some sort of fee for investing, 401(k) plans often have higher fees. Many of them will charge administrative fees related to the day-to-day handling of the account, investment fees for managing the funds within the account, and additional service fees, to name a few.
The average fee for large 401(k) plans (with an average of 1,000 participants and $50 million in assets) is around 0.88%, as of 2021, according to data from the National Association of Plan Advisors. Small plans (with an average of 100 participants and $5 million in assets) charge average fees of roughly 1.19%, as of 2021.
While that may not sound like much, it adds up over time. According to data from the Center for American Progress, the average worker who starts saving at age 25 will pay more than $138,000 in fees over a lifetime if they're charged 1% in annual fees. Meanwhile, that same worker would pay only $42,000 in lifetime fees with a 0.25% annual fee.
3. Your account is tied to your job
Unlike IRAs or other brokerage accounts, your 401(k) plan is tied to your employer. This isn't necessarily a bad thing, but if you're changing jobs relatively frequently, it could be tough to keep track of your savings.
If you leave your job, you generally have the option to cash out your 401(k) funds (and pay any taxes or penalties), transfer your money to a new 401(k) or IRA, or keep your money in your old account (without being able to contribute anything additional once you're no longer an employee).
Again, it's not the worst thing to have to manage your 401(k) when you leave a job. But investing in an IRA or other brokerage account can consolidate your investments, making it easier to manage your money.
One important caveat
While 401(k) plans do have their downsides, there's one important advantage to keep in mind: employer matching contributions. With a 401(k) match, your employer will match your contributions, usually up to a certain percentage of your salary.
The employer match is essentially free money and can instantly double your savings with next to no effort on your part. Even if your plan charges high fees or doesn't offer a wide variety of investments, it can still be worthwhile to invest enough to earn the full match. Then if you choose, you can invest the rest of your money elsewhere.
Contributing to a 401(k) is one of the simplest ways to get started saving for retirement, and it has its perks. But it won't be the right fit for everyone. By weighing the pros and cons of your 401(k), you can more easily determine whether it's the right place for your retirement savings.
