The Expert Podcast

So, there are many options for financial planning for retirement or financial security, and one of them has always been a 401k fund. The question is, is a 401k even a good idea anymore? Is it worth it to get into a 401k? Well, let's take a look at the pros and cons and why there might be some disadvantages to a 401k.

First of all, if you have your money in a 401k, it's locked up. You don't have a lot of access to the liquidity of that money. It's not like a bank account where you can just withdraw money from it. Certainly, you can take hardship withdrawals and do limited extractions from your 401k, but there are a lot of penalties and tax payments that come along with that. Your 401k balance has been accrued by tax-advantaged contributions from your paycheck, and if you start taking money out, you're going to have to pay back the taxes plus a penalty on top of that money.

In addition, you could take out a loan against your 401k, but now you're borrowing money and have interest payments on that loan. Another downside is that a 401k might have fees from the financial institution managing your account. If you have it in Fidelity or any other financial institution that runs 401ks, many times, they have annual fees or management fees that take away from your funds, and you want to take that into account.

The other downside to a 401k is that you have limited options for where to put your money. You may only have a certain selection of choices for the type of fund to invest in. It might be high-growth, interest-focused, or safety-oriented, and you might not be able to pick and choose stocks or decide where your money goes. Most 401k funds have a list of selected mutual funds that you can invest in, and beyond that, you don't really have any options.

Another downside is portability. If you leave your job or move, you have to switch your 401k over from one job to another. So, what are your alternatives to a 401k? Well, you could do an IRA (Individual Retirement Account). You can do a Roth IRA, which is similar. A SEP IRA is for self-employed people. You can also do regular brokerage accounts. Now, those are not going to have the tax advantages, but you may find that the additional investment options give you more benefits than the tax advantage.

Now, here's the thing: if you are getting an employer match to your 401k, then it's a no-brainer because it's free money, right? Some employers will match up to 2 or 3 percent of your income, and that's like free money. For example, if you make $100,000 a year and you put in $3,000, which is 3 percent, your employer will match it with an equal $3,000. Even if your balance in your accounts doesn't go up, you just made $3,000. So, employer match is a good advantage to a 401k.

But that's not always the case. Some employers don't match your contributions to your 401k. In 2023, there will be additional options for catch-up contributions. So, if over the last few years you haven't maxed out how much you can put in, you may be able to catch up and do additional payments to get your 401k balance as high as it could be.

Make sure you understand that if you are going to take out money from that 401k prior to your retirement, you need to know what those fees, penalties, interest payments, or tax payments are. A lot of times, people take the money out and don't realize what kind of tax liability that triggers.