Did you know that the average retired worker collecting Social Security today only gets about $23,000 a year? That's not a bad amount of supplemental income but not a particularly generous income by itself.
That's why it's so important to save for retirement on your own, and not just rely on Social Security to cover all your future expenses. When it comes to building a retirement nest egg, many people turn to their employers' 401(k) plans for the convenience and benefits involved.
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One nice thing about 401(k)s is that they're funded through payroll deductions. This means that once you sign up, your retirement plan will be funded automatically. It's not on you to remember to put money into your account each month.
Many employers that sponsor 401(k) plans match worker contributions to some degree. The result? Free money for retirement.
It's also worth noting that 401(k)s come with much higher contribution limits than IRAs. This year, you can put up to $23,000 into a 401(k) if you're under 50 or up to $30,500 if you're 50 or older.
IRAs max out at $7,000 and $8,000, respectively. And the more money you put into a 401(k), the more income you can shield from the IRS (assuming it's a traditional 401(k), not a Roth).
Maxing out a 401(k) could potentially set you up with a very nice retirement nest egg. But despite the benefits 401(k)s offer, there's a danger in maxing one out.
An imperfect savings solution
There's really a lot to like about 401(k) plans. But there are certain pitfalls you might encounter with a 401(k), specifically.
You may be limited in how you can invest. Unlike IRAs, which allow you to build a portfolio of individual stocks, 401(k)s generally limit you to a bunch of different funds. And that's problematic for two reasons.
First, any time you invest in a fund, you lose the opportunity to personalize your portfolio. If you buy into a mutual fund, for example, you're not the one deciding which assets it holds.
Second, the fact that you're limited to funds only in your 401(k) could mean getting stuck with costly fees, known as expense ratios. And if those fees are high enough, they could seriously eat away at your returns.
To be fair, there are options for minimizing your investment fees in a 401(k) plan. If you load up on index funds, they'll generally cost much less from an expense-ratio perspective than actively managed mutual funds.
Furthermore, it's common for 401(k)s to offer target date funds, which are truly the optimal "set it and forget it" type of retirement investment. Putting your 401(k) into a target date fund could mean facing costly fees, but it is a good option if you'd rather take a hands-off approach to building your retirement nest egg.
However, if you're someone who's good at choosing investments or who wants to learn how, then you may find that a 401(k) isn't the best home for your long-term savings. You may end up frustrated over your lack of control and annoyed by the hefty fees that eat away at your returns.
A better approach
If your employer offers a 401(k) match, it's a good idea to contribute enough to your workplace plan to claim it in full. But once you've gotten that match, you may want to look at other retirement savings options. That could mean falling back on an IRA, combined with a taxable brokerage account.
Although the latter account won't give you any tax benefits, it also won't restrict you in any way. You can withdraw from a taxable brokerage account at any age without penalties and contribute as much as you want to on a yearly basis.
There's nothing wrong with participating in an employer's 401(k) plan. But think carefully before maxing out your contributions.
