A 401(k) can be a great retirement investment account if your employer offers one. That's because many companies that provide these plans make matching contributions.
If your employer does offer a 401(k) match, you should always try to earn the full amount of funds the company will give you. But beyond that, you may want to think about not putting more money into your 401(k) and doing other things with it instead.
Here's why.
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Investing extra money in your 401(k) may not make sense
Contributing enough to get your full 401(k) match is a no-brainer, since otherwise you'd leave free money on the table. If your employer matches 50% or 100% of your contributions up to a percentage of your salary, you can get a risk-free 50% or 100% ROI.
The problem is that once that money is invested, you are very limited in what you can do with it. It must go into the plan your company created, and most 401(k) plans offer very few investment choices. One report from 2020 found the largest corporate plans provided fewer than 16 investment options within their 401(k) plans.
Data also showed that the number of investments on offer within 401(k)s had declined over the years, and that many workers who invested in 401(k)s now end up simply buying one single target-date retirement fund rather than a mix of different investments.
Sadly, target date funds (and many of the other funds within 401(k) plans) can sometimes come with higher expenses than investments you might find at a regular brokerage firm. Plus, if you want to do things like invest in individual stocks, that's off the table.
What else can you do with your extra retirement money?
So you're probably wondering what you should do with the rest of your retirement money if you don't contribute to your 401(k) beyond the amount needed to earn the employer match.
There are great answers to this question.
Specifically, you can put it into a traditional or a Roth IRA. A traditional account offers the same tax breaks as your traditional 401(k). Your contributions are deducted from your taxable income in the year that you invest in your account. A Roth offers the same tax breaks as Roth 401(k) accounts (which not all employers offer). Contributions into your Roth aren't deductible when made, but withdrawals are tax free.
Both traditional and Roth accounts give you the chance to invest in many more assets, including individual stocks and even alternative investments like cryptocurrencies. Or you can choose a mix of low-cost ETFs, which can give you exposure to the market as a whole, or to specific industries. Often, ETFs come with lower expense ratios than the funds in your 401(k).
So don't limit your investment options and increase your fees by putting all of your retirement money into your employer plan. Once you've earned your match, open an IRA and invest there instead. You can contribute up to $7,000 in 2024, or up to $8,000 if you are 50 or older.
If you happen to max out IRA contributions, then you can go back to 401(k) investing to claim the remaining deductible contributions. But if you don't have enough funds to max out all your tax advantaged plans, it just makes sense to diversify out of the 401(k) environment and get the benefits that IRAs offer.
