There are many reasons I’m not a big fan of 401Ks, including, but not limited to, their fees, restricted investment options, and lack of flexibility. The structure of a traditional 401(k) also raises concerns about future tax rates and the inability to access your money during your peak earning years.
- Limited investment choices. Unlike a brokerage account, your 401(k) often offers a limited, pre-selected menu of investment options, typically mutual funds. If these options perform poorly or have high fees, your retirement savings could suffer.
- Hidden and excessive fees. 401(k) plans and the investment funds within them charge fees for administration and management. These fees, which can be difficult to find and understand, eat into your investment returns over time. According to one estimate, a 1% annual fee can cost hundreds of thousands of dollars in lost growth over a lifetime.
- Giving up control. With a 401(k), you entrust your money to fund managers whose interests may not fully align with yours. This lack of control is further highlighted by the fact that your investments are limited to paper assets rather than hard assets like real estate.
- Severe withdrawal restrictions. Generally, you cannot access the money in a 401(k) without penalties until age 59½, making the money “illiquid”.
- High costs for early withdrawals. If you need to make an early withdrawal, you will likely pay a 10% penalty on top of regular income taxes. For many young workers who face emergencies or high-interest debt, raiding their 401(k) for quick cash can have steep long-term consequences.
- Complicated rollovers. When you change jobs, you must decide whether to leave your funds in the old plan, roll them into your new employer’s plan, or move them to an IRA. The process can be a headache, leading many people to forget about old accounts entirely.
- Taxed as ordinary income. Withdrawals from a traditional 401(k) in retirement are taxed as ordinary income, not at the lower capital gains rate. If your tax bracket is higher in retirement, you could end up paying more taxes than you saved by deferring them.
- Unpredictable future tax rates. Predicting your tax bracket decades from now is impossible. If federal tax rates rise in the future, your retirement withdrawals could be taxed at a much higher rate than you anticipated.
- Required minimum distributions (RMDs). With a traditional 401(k), the IRS forces you to start withdrawing money and paying taxes on it once you reach a certain age, currently 73. This removes some of your control over your own savings.
- Contribution limits. The government caps how much you can contribute each year, which may prevent high-income earners from saving enough to fully fund their retirement.
My business partner, Dave Suckey, heads up a team that specializes in a great alternative to traditional financial planning:
We specialize in retirement and estate planning, along with how to maximize exiting a business:
