When you start investing, your 401(k) is often the easiest place to begin because the account is already set up for you and your contributions can automatically be deducted from your paycheck.
However, many 401(k)s are behind in offering high-quality, low-cost investment options that maximize your odds of success.
So, how do you know if you have a 401(k) that is good or is bad? And if it’s bad, what should you do?
In this guide, I’ll help you figure it out.
Three Big Indicators Of A Bad 401(k)
Here are three big indicators of a bad 401(k)
1No Employer Match
Many employers offer a matching contribution. This means that every time you contribute to your 401(k), your employer contributes as well — up to a certain limit.
This is a fantastic benefit and it’s the main reason that most people should prioritize their 401(k) over other retirement accounts when they first start out.
And if you are lucky and your employer matches your contributions dollar per dollar – or even half of that – there isn’t a better return on investment anywhere else.
If you don’t have an employer match, it doesn’t mean that you should avoid your 401(k).
However no match does remove the big advantage that the 401(k) has over other retirement accounts. You should start looking at other options if your employer does not offer a match.
The single best predictor of future investment return is cost. The less an investment costs, the more likely it is to produce higher returns.
Many 401(k)s are littered with fees that eat away at your retirement savings. There are a number of different types of fees to watch out for that range from the cost of your investments to various administrative fees.
If your 401(k) does charge excessive fees, you should think twice before contributing your hard-earned savings.
3Limited Investment Options
401(k)s have limited investment options by definition.
Your employer, along with the plan sponsor, chooses a set of investments to include in the plan. This set of investments is all you have to work with.
This need not be a problem. It’s certainly possible to choose a small set of fantastic investments, and many plans do just that.
However your 401(k) may not have the specific investments you want. If that’s the case, you may want to balance your 401(k) with other accounts in order to implement investment strategy.
Bear in mind if your employer gives you a match and the fees are reasonable, you can almost always find at least one good fund.
So don’t ignore your 401(k) because you can’t invest exactly the way you want.
What Do You do With A Bad 401(k)
If your 401(k) falls into one or more of the categories above, what should you do? Here are some things you can do with your 401(k) if it’s “bad”
4Take the Employer Match
It’s worth taking a matching 401(k) contribution, even if you’re charged excessive fees.
5Prioritize Other Tax-Advantaged Retirement Accounts
When you have maxed out the employer match, or if your employer doesn’t offer a match, then you’ll likely be better off prioritizing other retirement accounts.
You need to do this so you can minimize your fees and have greater control over your investment choices.
This means that in all likelihood you will start out with either a traditional or Roth IRA.
Another great option is a health savings account. These accounts offer special tax benefits when used for medical expenses, but in the right situations they can also be a powerful retirement account.
6Pay Down Your Debt
If you look at the interest rate on your debts as a guaranteed return on investment, prioritizing extra debt payments over retirement savings can make a lot of sense, particularly if the only alternative to retirement investments is a bad 401(k).
7Use Taxable Investment Accounts
Whether or not to use a taxable investment account over a 401(k) is a complicated question. It depends on your particular situation.
Here are a few points to consider:
- Your 401(k) would have to be extremely costly for the fees to outweigh the tax benefits of a taxable investment account. Very very costly
- A taxable investment account would start to be more appealing the longer you plan to stay with your current company, because the 401(k) fees have more impact
- The tax deduction and tax-free growth within a 401(k) will be more advantageous in higher tax brackets.
Bad 401(k) Summary
A bad 401(k) isn’t great – but it’s not the end of the world
If you do your homework and get advice, you can still save and invest well for retirement
The real key to investment success is saving enough money. This is true no matter where you put that money.
If you focus on saving well first and do your best you can with the rest of the equation, you’ll be just fine.