You may want to look outside of your employer's retirement plan.
If you don't make an effort to save for retirement, you may be forced to live on Social Security alone. And that could lead to a pretty cash-strapped retirement for you.
A much better bet is to fund a retirement plan throughout your working years. And if your employer offers a 401(k), you may be inclined to sign up -- especially if that plan comes with a generous match.
Now it's always a good idea to snag your 401(k) match in full. After all, that's free money for your retirement.
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But while it's one thing to put some of your retirement savings into a 401(k) plan, it's another thing to put your entire nest egg into one of these accounts. Here are three pitfalls you might encounter if you only save for retirement in a 401(k).
1. Limited investment choices
When you invest for retirement in an IRA, you generally get the option to build a portfolio that consists of individual stocks. With a 401(k), your investment choices are usually far more limited. You're typically looking at a mix of different funds to choose from, and you can't buy stocks on an individual basis.
If you're someone who's good at picking stocks, you may want to consider opening an IRA on top of a 401(k) for retirement savings purposes. That could help you build a portfolio that's more conducive to meeting your goals.
2. High fees
Because 401(k) plans tend to limit your investment choices, you may end up having to put your money into funds that come with costly fees, known as expense ratios. On top of that, there can be administrative fees associated with your 401(k) that are passed on to you.
With an IRA, your fees might be lower. And the less money you're losing to fees, the more you stand to retire with.
3. Early withdrawal penalties
Some people end up plugging away at their careers well into their 60s or even beyond. But maybe you have high hopes for an early retirement. If so, keeping all of your money in a 401(k) plan could be a big mistake.
With a 401(k), you're generally looking at a 10% early withdrawal penalty for removing funds prior to age 59 1/2. Now there can be an exception to this rule if you separate from the employer sponsoring your 401(k) in the calendar year in which you turn 55 (or later). In that case, you may be able to get your money penalty-free starting at age 55.
But if you know that early retirement is on your radar, then you may want to put some of your savings into a taxable brokerage account. That way, you'll have unrestricted access to your money when you want or need it.
There's nothing wrong with using a 401(k) to save for retirement. But you may want to think twice about putting all of your long-term savings into a 401(k). Branching out into an IRA and a taxable brokerage account could help you limit your fees, open the door to more investment choices, and ensure that you have access to your money at all times.
FAQs
Most plans have limited flexibility as it relates to quality and quantity of investment options. There can be early withdrawal penalties equal to 10% of the amount withdrawn before age 59 1/2.
What is a disadvantage of using a 401 K for retirement savings? ›
Most plans have limited flexibility as it relates to quality and quantity of investment options. There can be early withdrawal penalties equal to 10% of the amount withdrawn before age 59 1/2.
What are the downsides of a solo 401k? ›
Drawbacks to the solo 401(k)
Like other 401(k) plans, the solo 401(k) will hit you with taxes and penalties if you withdraw the money before retirement age, currently set at 59½. Yes, you can take out a loan or may be able to access a hardship withdrawal, if needed, but those are last resorts.
What is the problem with the 401k savings plan for retirement? ›
The amount of cash that's in the fund when you retire is what you will receive as a pension. Thus, there is no guarantee that you will receive anything from this defined contribution plan. The fund may lose all (or a substantial part) of its value in the markets just as you're ready to start taking distributions.
What is the catch up for solo 401k? ›
The total solo 401(k) contribution limit is up to $69,000 in 2024. There is a catch-up contribution of an extra $7,500 for those 50 or older. To understand solo 401(k) contribution rules, you want to think of yourself as two people: an employer (of yourself) and an employee (yes, also of yourself).
What are the disadvantages of a simple 401k? ›
Limited Investment Choices
Employees cannot diversify their investments since it limits them to one type of plan. They cannot use other types of retirement plans, and they cannot choose from different investment choices.
What are the pros and cons of 401k vs pension? ›
A 401(k) allows you some control over your fund contributions, while a pension plan does not. Pension plans guarantee a monthly check in retirement a 401(k) does not offer guarantees. However, 401(k)s are portable, meaning you can roll them over into another account should you change employers one or multiple times.
Can a solo 401k be sued? ›
Retirement account protections against creditors are similar to those described above: ERISA-qualified retirement plans are usually fully protected, while IRA protections vary by state. If you have an independent 401(k) due to self-employment, your retirement account can be seized in a civil lawsuit in some states.
Is 401k alone enough for retirement? ›
Even if you're contributing the max allowable to your 401(k), it may still not be enough. There are a lot of good reasons to invest in your 401(k), but consider other ways to save, including IRAs, investment accounts and savings accounts.
Who Cannot open a solo 401k? ›
No Full-Time Employees
In order to sponsor the simplified Solo 401(k), however, there can be no non-owner employees of the business that work more than 1,000 hours per year (about 20 hours per week).
Pro: 401(k)s can help you budget for retirement. Con: It can be difficult to access funds early. Pro: You'll save on taxes while working. Con: You might pay higher taxes later.
Why not to save in 401k? ›
Putting money into a 401(k) doesn't make sense if you turn around and pull it right back out again. According to a recent TIAA-CREF survey, nearly a third of Americans have borrowed from their retirement account at some point. Approximately 35% of those who took out a retirement loan did so to cover emergency expenses.
Why people don t invest in 401k? ›
Although 401(k) plans are an excellent way to save, it may not be possible to set aside enough for a comfortable retirement, in part because of IRS limits. Inflation and taxes on 401(k) distributions erode the value of your savings.
What is the downside of a Solo 401k? ›
However, there are some downsides you should consider. Like most retirement plans, you'll get hit with taxes and fees if you withdraw the funds before the age of 59½. "One disadvantage is that you must have a triggering event, usually retirement or ending employment, to take a distribution," says deMauriac.
What is the rule of 55 for Solo 401k? ›
This is where the rule of 55 comes in. If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.
What is the difference between a 401k and a Solo 401k? ›
While both Individual 401k and Solo 401k are for the owner-only business owner/self-employed, brokerage firms and large financial institutions generally refer to their owner-only 401k as Individual 401k. Generally, these firms only allow you to invest Individual 401k in mutual funds and stocks.
What are the downsides of withdrawing from 401K? ›
As much as you may need the money now, by taking a distribution or borrowing from your retirement funds, you're interrupting the potential for the funds in your 401(k) plan account to grow through tax-deferred compounding — and that could make it more difficult for you to reach your retirement goals, says Feist.
What is a benefit of using a 401 K for retirement savings? ›
Tax advantages
Because the contributions are pre-tax, it lowers your total taxable income which means you might owe less in income taxes, regardless of whether you itemize or take the standard deduction. It may even put you in a lower tax bracket!
What is a disadvantage of a contribution retirement plan? ›
Cons. Unknown benefit amount: Because your pension benefit is based on how well your investments perform, you won't know your benefit amount until retirement. Investment risk: Much of the risks and rewards fall on your shoulders because you choose your investments based on the plan's options.
What is an advantage to a 401 K retirement plan quizlet? ›
An advantage of a 401(k) plan is that you get to use your contributions as a tax deduction. An advantage of the 401(k) is that your earnings get to grow without being taxed until you withdraw them.
