The average retired worker today gets about $1,920 per month from Social Security, or roughly $23,000 per year. Since that's not a lot of money to live on, you may want to push yourself to build savings for retirement during your working years. And if you have access to a 401(k) plan through an employer, you may decide that participating in it is your best bet.
The nice thing about 401(k) plans is that they allow contributions to be deducted from your pay automatically. For some people, that's the ticket to staying on track with long-term savings.
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Plus, it's common practice for employers to offer some type of 401(k) match. Even if yours is a small one, that could mean free money for your savings.
But while a 401(k) plan might seem like a great choice for your retirement savings, there are certain flaws you should know about. Here are three to keep on your radar.
1. Limited investment choices
If you save for retirement in an IRA, you can generally hand-pick a portfolio of stocks with the potential to beat the broad market. With a 401(k), it's harder to do that because these plans generally do not allow you to hold stocks individually.
Rather, 401(k)s generally limit you to different funds that include mutual, target date, and index funds. These options don't tend to bother people who consider themselves hands-off investors. But if that's not you, then a 401(k) might frustrate you -- and limit your savings' growth.
2. High fees
It costs money to administer a 401(k) plan. However, those costs may be getting passed along to you in the form of expensive fees. If you're paying more than 1%, it's not a good sign.
But administrative fees aside, if you don't choose your 401(k) investments carefully, you might also pay fees for the funds in your account. Index funds are generally a safer bet when it comes to investment fees, since they're passively managed. Mutual or target date funds, on the other hand, tend to come with higher fees (which are called expense ratios) that have the potential to erode your returns.
3. Not actually getting your employer match
While many companies match worker contributions to 401(k)s to some degree, you're not actually guaranteed that money. It's also somewhat common for employers to impose a vesting schedule that requires you to remain on their payroll for a period of time in order to actually take ownership -- or full ownership -- of that free money.
You may, for example, have an employer that will match contributions to your 401(k), up to 5% of your salary each year. But you may also be subject to a vesting schedule that requires you to remain employed for three years to get your match, or otherwise end up with nothing.
Be mindful of these 401(k) drawbacks -- and consider an IRA instead
While it's not necessarily a poor choice to save for retirement in a 401(k) plan, you should at the very least be aware of these pitfalls. And you should consider putting at least some of your long-term savings into an IRA.
You may find that an IRA charges lower fees. And as mentioned, you'll commonly get more investment choices.
Of course, the one thing you won't find in an IRA is an employer match. But considering that actually claiming your 401(k) match may not be feasible depending on your company's policies, that doesn't necessarily have to be a deal breaker.
