Between turbulent financial markets, high fees, and a lack of employer support, many workers are just about ready to give up on their 401(k) retirement plans. But even though many of the criticisms of employer-sponsored retirement plans are valid, you can still navigate the twists and turns of the 401(k) world to make great use of the plans to help you retire comfortably and securely.
Why everyone hates 401(k)s
Plenty of hawkers of financial advice -- myself included -- dwell at length about the value of 401(k) plans. They let you set aside relatively huge amounts of money -- $17,000 in 2012 -- and give many people the largest tax deduction they'll get on an annual basis, saving thousands in current income taxes. Used correctly, they also impose discipline on savers, locking away money to devote toward the single purpose of saving for retirement.
But while the theory behind 401(k) plans is solid, what happens in practice often falls short of the ideal. Consider some of the black marks against 401(k)s:
- To many, the very existence of the 401(k) plan is an affront to the notion that employers should directly provide for their workers' retirements through traditional pension plans. Yet this year, Bank of America (NYSE: BAC) and General Motors (NYSE: GM) have joined the dozens of employers that have frozen at least some of their workers' pension plans in recent years, instead shunting workers toward 401(k) plans.
- Typically, a company that moves from a traditional pension to a 401(k) plan will make additional employer contributions toward workers' retirement. Yet during the recession, Ford (NYSE: F) and FedEx (NYSE: FDX) were just two of the many companies that suspended employer matching contributions. Although they've since restored their matching, the episode shows that workers can't count on employers to stand by them in tough times.
- 401(k) plans lock workers into a fixed slate of investment options. If employers choose wisely, they may give workers access to strong low-cost investments. But all too often, employers pick investments with high fees in order to minimize their own administrative costs, which can lead to workers paying hundreds of thousands of dollars in extra costs over their careers.
- Given how often people switch jobs, 401(k) plans present a challenge in that they're tied to a particular employer. Although you can transfer 401(k)s to a new employer or to a retirement account of your own, it introduces an additional hassle. Moreover, with some employer contributions requiring you to stay at a job for a certain minimum period, many workers end up forfeiting those employer contributions when they switch jobs too soon.
With all these downsides, it's a wonder why anyone uses 401(k) plans. But with some work, it can still be worth it to save in an employer-sponsored plan.
Be smart with your retirement
The key to making the most of your 401(k) is to find its strengths. Most 401(k)s have a combination of high-fee actively managed funds and low-cost index funds. If you stick with the low-cost alternatives, you'll generally do better over the long haul.
In addition, don't look at switching jobs as a hassle but rather as an opportunity. Whenever you switch jobs, you can take 401(k) money and roll it into an IRA that you have complete control over. The rollover lets you pick nearly any investment you want, so even if you're stuck in a high-fee 401(k), you can then save a bundle by moving your money into your IRA and choosing better investments of your own.
Finally, pay at least minimal attention to vesting rules for employer contributions. I'm not saying you should stay at a job you hate for an extra couple of years in order to keep a few thousand dollars of matches. But if it's a matter of sticking it out for a month or two, it may be worth the effort.
Don't give up
401(k)s deserve the criticism they've gotten, but that doesn't mean you should give up on them. Used correctly, 401(k)s can still play an incredibly valuable role in helping you retire rich in the long run.
To learn more about how to use 401(k)s to put together a complete retirement solution, let me suggest reading The Motley Fool's special report on retirement. It includes not only some general advice on retirement investing but also the names of three stocks that could fit well in your retirement portfolio. Don't wait -- click here and start reading your free copy right now.
