13 Problems With Relying on Only Your 401(k) for Retirement

Contributing money to a 401(k) for retirement is a smart financial move -- especially if your employer offers you matching contributions.

But, for most people, using only a 401(k) for investing isn't the best approach. Here are 13 reasons why it can pay to diversify into other investment accounts along with your 401(k).

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If you're hoping to leave the workforce ASAP, a 401(k) may not provide you with money early in your retirement years. That's because you typically can't start taking money out until 59 1/2, or age 55 under some circumstances.

You'll need money in another account to support you until you can start making penalty-free withdrawals if you're anticipating quitting for good in your early or mid-50s.

Although there are a few hardship exemptions, early withdrawals from a 401(k) result in a 10% penalty. This can make it really difficult to access invested funds if you need them. While you can take a 401(k) loan, not all plans allow that and there are limits on the amount.

A taxable investment account, on the other hand, allows you to invest money you can take out whenever you need it. And a Roth IRA provides more flexibility because you can withdraw contributions at any time without tax penalties.

Raiding your retirement accounts early typically isn't a good idea, but still you may not want to put all your retirement funds in a 401(k) and tie them up where penalty-free access is so restricted.

In most 401(k) accounts, you're limited to choosing from a small pool of investment options -- most of which are index funds.

If you want to invest in individual stocks to help you grow your retirement nest egg, or if you want a broader choice of exchange-traded funds and mutual funds to invest in, you'll need to diversify into a different kind of retirement account.

ALSO READ: 2 Stocks to Help You Build Retirement Wealth

Many 401(k) accounts come with an administrative fee. These fees can eat into your returns, especially if you're investing a lot of money into your account over a long period of time.

Putting some of your retirement savings into a fee-free IRA could help you avoid these costs and make it easier to build wealth for your later years.

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When you invest in a 401(k), you make your contribution with pre-tax money. Your tax savings comes in the year you contribute. But you have to pay taxes as a senior when withdrawing funds.

Other retirement accounts, such as a Roth IRA, reverse when you get your tax benefits. Money can be withdrawn tax-free as a senior, but you invest with after-tax money.

If you aren't confident that your tax bracket will be lower as a retiree, you may not want to claim all your tax savings up front. Instead, you may decide to put some money into a Roth and the rest into your 401(k).

Social Security benefits become subject to federal (and possibly state) tax once your income reaches a certain threshold.

If you've used a 401(k) to save for retirement, all of your distributions from that 401(k) count toward the income used to determine if you'll owe tax on Social Security benefits.

By contrast, distributions from a Roth IRA won't count toward the income used for this calculation. By saving some of your nest egg in a Roth account instead of a 401(k), you may be able to keep your countable income low enough that your benefits remain tax-free.

Although the tax benefits of a 401(k) can be pretty great, there's actually an account that provides even more potential savings. It's a health savings account.

HSAs allow you to contribute with pre-tax dollars and grow your wealth without being taxed, just as 401(k)s do. But if you withdraw funds for qualifying medical expenses, withdrawals are also tax-free. A 401(k) doesn't provide this added savings.

If you are eligible for an HSA, you should be keeping some of your retirement savings in it so you can claim the triple tax break and prepare for healthcare expenses as a retiree.

ALSO READ: 3 Reasons to Keep Your Retirement Savings Outside a Retirement Account

Money in a 401(k) is subject to required minimum distribution (RMD) rules. These mandate that you begin making withdrawals starting at age 72. IRS rules specify exactly how much you have to take out based on life expectancy and your account balance.

Other accounts, such as Roth IRAs and HSAs, aren't subject to RMDs. If you don't want every dollar of your retirement savings subject to RMD rules, diversifying into other accounts is a good idea.

Some 401(k) plans limit when and how you can take your distributions as a retiree. For example, you may not be able to withdraw money every two weeks if you want to do so to mimic getting a paycheck.

If you'd prefer more flexibility in how your withdrawals are structured, you may prefer another retirement plan that gives you more control over accessing your cash.

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There are limits on how much money you can contribute to a 401(k) annually. While the limits are pretty high, it's still possible you will want to invest more than the allowable amount.

If that's the case, you'll need to put some of your money into a different type of retirement investment account.

Although all tax-advantaged retirement plans do have annual contribution caps, contributing to multiple accounts allows you to save much more each year in total.

ALSO READ: 401(k) Contribution Limits for 2020 and 2021

Once you've retired and left your job, you can't contribute to a 401(k) anymore. This is different from most other tax-advantaged retirement accounts, which allow you to contribute as long as you have earned income.

Some people would prefer to keep investing for the later years of their retirement even after giving up their primary position. If you're one of them, you'll need to use a different kind of account.

401(k) contributions must be withdrawn from your paychecks, and you have to sign up at work and specify how much you want contributed each pay period.

This can make it difficult to add money to the account if you happen to get a windfall, such as a cash gift that you decide you want to invest for your future.

With other kinds of retirement accounts such as IRAs, you can just move money over to them when you want to as long as you haven't hit your annual contribution limits. This gives you more flexibility to make random contributions that help build your wealth.

If a market crash occurs, stocks go on sale. You may decide you want to take the opportunity to temporarily increase the amount you're investing so you can buy assets at a discount.

This can be hard to do with a 401(k), since you'd need to sign up with your employer to increase contributions and this sometimes takes several pay periods to go into effect.

You'll want to use another account if you hope to be able to increase investing amounts quickly in response to market downturns.

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As you can see, there are plenty of reasons why you should look beyond your 401(k) when deciding where to put your investment dollars.

After you've invested enough to earn the full amount of your employer match, take the time to consider whether some of your funds should go elsewhere besides your 401(k).

You may end up being very glad you diversified your investment accounts in the end.

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