3 Surprising Disadvantages of Investing in Your 401(k) | personal finance

(Stefon Walters)

Having the option to invest in a 401(k) plan is a blessing for many people; In the short term, you can 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 drawbacks to investing in a 401(k).

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1. Investment options are limited

Unlike a brokerage firm or IRA, you can’t count on being able to invest in just one company or fund of your choice in a 401(k). Whoever your plan provider is, they will give you the investment options you can 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 probably an international fund. Options vary by plan, but you can generally expect to see them.

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Having only a handful of options to choose from can be a limitation for people who want a little more control over their investment choices.

2. Costs are higher than you think

401(k) fees can be more expensive because they have a few layers. First, you’ll need to pay plan administrative fees, which go to your plan provider for all necessary administrative paperwork, such as record keeping, fiduciary services, and bookkeeping. It will also cover any extra activities your plan offers, 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 you 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 retirement approaches.

There is also the possibility that your plan may charge more for other individual services. In addition to the standard buying and selling, you could face service fees for things like getting a loan from your plan, transferring your 401(k) to a different plan, or seeking help from financial counseling. Before you do those things, double check with your plan to see if it might cost you and how much.

3. Early withdrawal options are limited

One thing about a 401(k) plan is that it tries to do everything it can to discourage you from withdrawing money before retirement. This isn’t necessarily a bad thing, but you’ll see how limiting it can be compared to retirement accounts like IRAs. Both account types will face a 10% early withdrawal penalty, but there are more exceptions with IRAs.

Money can be withdrawn from an IRA for qualified higher education expenses for you, your children, spouse or grandchildren without penalty. First-time homebuyers can also withdraw up to $10,000 to cover the cost. And you can even make withdrawals from an IRA to pay for health insurance premiums while you’re unemployed. Neither of those things is possible with a 401(k) without facing the 10% early withdrawal penalty (and income taxes on the amount withdrawn).

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