Having the ability to invest in a 401(k) plan is a blessing for many people; in the short term, you reduce your taxable income and save money on taxes, and in the long term, you put yourself in a position to live financially comfortably in retirement. Using a 401(k) is one of the best things anyone can do to protect their financial future.
However, a 401(k) is not without its drawbacks. Here are three surprising downsides to investing in a 401(k).
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1. Investment options are limited
Unlike a brokerage firm or an IRA, you cannot rely on the ability to invest in a single company or fund of your choice in a 401(k). Regardless of your plan provider, you’ll find investment options to choose from. These typically include your company’s stock (if public), target date funds based on your projected retirement year, funds grouped by market capitalization, and possibly an international fund. Options vary by plan, but you can generally expect to see them.
Having only a handful of options to choose from can be limiting for people who want a little more control over their investment choices.
2. The costs are higher than you think
401(k) fees can be more expensive because they have a few layers. First, you will need to pay a plan administration fee, which will be paid to your plan provider for all necessary administrative tasks like record keeping, trustee services and accounting. It will also cover any additional activities offered by your plan, such as educational seminars and other services.
Then you can expect to pay investment fees, which make up the bulk of 401(k) fees. They are charged as a percentage of the amount invested and vary by fund. For example, an expense ratio of 0.50% would mean that you would be charged $50 for every $10,000 invested. If the fund is actively managed, the fees are likely to be higher, as is the case with target date funds, which are reallocated to become more conservative as you get closer to retirement.
Your plan may also charge additional fees for other individual services. Besides the standard buying and selling, you might incur service fees for things like taking out a loan from your plan, transferring your 401(k) to another plan, or looking for a loan. financial assistance. Before you do these things, check with your plan to see if and how much it might cost you.
3. Early withdrawal options are limited
One thing about a 401(k) plan is that it tries to do as much as possible to dissuade you from withdrawing money before retirement. That’s not necessarily a bad thing, but you see how limited it can be compared to retirement accounts like IRAs. Both types of accounts will face a 10% early withdrawal penalty, but there are more exceptions with IRAs.
Money can be withdrawn from an IRA for qualified college expenses for you, your children, your spouse, or your grandchildren without penalty. First-time home buyers can also withdraw up to $10,000 to cover the cost. And you can even withdraw from an IRA to pay health insurance premiums while you’re unemployed. None of this is possible with a 401(k) without facing the 10% early withdrawal penalty (and taxes on the amount withdrawn).
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