When to Say ‘No Thanks’ to Your Workplace 401(k)

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One of the most valued employee benefits is the ability to save for retirement through a workplace plan, such as a 401(k) or 403(b). The majority of plans are a great deal for employees, and over the years, the design of 401(k) plans have been tweaked to help workers make smarter choices.

But some plans, typically smaller plans with fewer participants and, thus, fewer total assets, lack important features. If your plan is subpar on more than a few key elements, it’s worth considering doing your saving elsewhere. Here are key questions to ask yourself, and your employer, before you decide:

Do you intend to contribute more than $6,000 per year, or, if age 50 or above, more than $7,000? Those are the 2020 contribution limits to an IRA. If the answer is yes, then a 401(k) is the better option, as you can save more than triple those sums in a workplace place. But if your contributions will be no more than $6,000/$7,000, a 401(k) isn’t necessarily best.

Is there a Roth option? An estimated 70% to 80% of plans now offer a Roth 401(k). That’s a terrific option for anyone 40 or younger. It also can make great sense for the 50+ crowd who’ve done a lot of saving in a Traditional 401(k) to add some Roth 401(k) savings to their mix.

If your plan doesn’t offer a Roth, and you expect your 2020 modified adjusted gross income to be less than $124,000 (single tax filer) or $196,000 (married filing jointly), and you don’t expect to contribute more than $6,000 or $7,000, a Roth IRA deserves serious consideration.

Does the plan offer a match? If you work at a small firm or a startup, you might not get a match. Fewer than 60% of plans with less than $1 million in total plan assets offer a match, and 20% of plans with between $1 to $10 million fail to pony up a match.

Do you have a new job where you must wait until you’re eligible for the match? Many plans don’t match until your one-year anniversary. Do you need to participate for a year (without a match) to eventually be given the match? If not, and there’s no Roth option, and you’re not going to save more than $6,000/$7,000, a Roth IRA might be a good move for the first year on your new job.

Is the match “cliff” or “graded” vesting? If you get a match, the technical advice is that you’d be nuts to pass it up. That’s generally true. But it’s worth asking more, including whether you expect to make a career move any time soon.

Welcome to the world of “vesting.” That’s the term for how fast (or not) the matching contribution is yours forever and always. To be clear, what you contribute to your 401(k) account is always yours from the first day. Vesting only applies to the match. If you leave a job — voluntarily or not — before your employers’ matching contribution has fully vested, you forfeit some of the match in your account.

According to a retirement plan association, about 40% of plans that make a match consider it “immediately vested.” That is the best retirement savings deal on the market.

But 60% of plans have a vesting schedule. Some plans use the “cliff” vesting system: The money is put into your account, but you get 0% if you leave the job before a set period. Six% of plans have a two-year cliff and another 12% have a three-year cliff. The other vesting method is called “graded.” Each year a portion of the matching contribution becomes irrevocably yours. Some plans vest 20% a year, so if you leave the next year you will forfeit 80% of the match you received in the prior year.

Ask HR. And if your match is cliff vested, and you are pretty sure you are going to leave your job soon-ish, and there’s no Roth option, you should weigh whether a Roth IRA might be a better fit as you plot your transition.

Is there a broad U.S. stock market option with an expense ratio below 0.50%? The investment choices in a 401(k) are typically mutual funds, or their bespoke cousins: collective investment trusts.

Funds and CITs offer instant diversification; they typically own dozens, if not hundreds or thousands of individual stocks. Every fund and CIT charges an annual fee to operate and manage that fund. The weighted average is around 0.50% for a U.S. stock fund. That may seem like peanuts, but it is anything but. If you invest on your own at a discount brokerage, there are options that charge an annual expense ratio of less than 0.10%. Fidelity actually has a suite of funds that don’t have any expense ratio.

If you invest $10,000 a year in a fund that earns an annualized gross return of 8% for 30 years, and it charges an 0.10% expense ratio, your account will be worth around $1.2 million. If instead, the fund charges an 0.50% expense ratio, you will end up with around $1.1 million. That’s $100,000 less simply because of the seemingly inconsequential difference in the annual expense ratio.

If your plan doesn’t have any broad U.S. stock fund with a very low expense ratio — it typically will be an index fund — that’s a yellow light.

Ultimately, deciding whether to invest in the 401(k) requires you to walk through your own decision tree based on your plan’s particulars and your career objectives.

If there’s no matching contribution, or a long cliff vesting of the match, that should motivate you to consider other variables. You may want to focus on an IRA first. Or if you’re angling to save even more, there’s no rule that says you can’t fund an IRA and a 401(k). Contribute the max to a Roth IRA if you’re eligible, while simultaneously using your workplace Traditional 401(k) account to sock away even more for retirement.


(Article written by Carla Fried)