Not everyone works for a company that offers a 401(k) plan, and even if you do for part of your career, that may not be the case for all of it. But if you do have access to a 401(k), there are certainly benefits to participating in it.
For one thing, it's easy to fund a 401(k). All you have to do is tell your employer what percentage of your wages you want to contribute, and voilà -- funds get routed into your account automatically each month.
Also, many employers that sponsor 401(k)s also match worker contributions to some degree. In those cases, if you put in some money of your own, you'll end up with a nice chunk of extra money from your employer as well.
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In fact, it absolutely pays to put at least enough money into your 401(k) to snag your employer match in full. But beyond that, it could pay to find another vehicle for some of your retirement investments.
The problem with 401(k)s
One major issue that tends to arise with 401(k) plans is that they only offer access to a limited number of investment choices. Most employers and their plan providers will give investors a menu exclusively of mutual funds and exchange-traded funds to pick from. Some of those mutual funds, such as target date funds, can carry relatively high fees.
By contrast, with an IRA, you can buy stocks individually, along with whichever funds you'd like, and combine those assets to build a portfolio personalized to your desires.
Now, one type of fund you're likely to find in a 401(k) is an index fund -- or multiple choices within that realm. And the nice thing about index funds is that since they're passively managed, their fees tend to be on the low side.
But your 401(k) plan might also cost you a lot in terms of administrative fees. And those are fees you can't control. With an IRA, you may find that your fees are much lower overall. Between that and the fact that an IRA gives you more say over how your retirement nest egg is invested, it could be a good idea to fund your 401(k) until you've earned your full employer match, but from there, put your money into an IRA.
Consider a taxable brokerage account, too
Because 401(k)s and IRAs offer tax benefits, there are added rules associated with taking withdrawals from them. Unless you qualify for an exception, tapping an IRA or 401(k) before you turn 59 1/2 will cost you a 10% early withdrawal penalty.
But what if -- for example -- you end up being in a position to retire at 57? At that point, you'll be years away from eligibility for Social Security. Wouldn't it be frustrating to be sitting on enough money that you could retire, but to be unable to use it for another couple of years without paying a steep penalty, and as a result, have to keep working?
The possibility that you might want more financial flexibility for one reason or another provides an excellent reason for investing some of your long-term savings via an ordinary taxable brokerage account. That way, you can take withdrawals penalty-free at any time. All you'll have to worry about are capital gains taxes. But to be fair, unless you save in a Roth account, you will pay ordinary income taxes on your withdrawals from 401(k)s and IRAs, too.
All told, a 401(k) can be a handy and powerful tool for building a nest egg. But it's probably a good idea to invest for retirement using other types of accounts as well.
