Home > 2016 > Personal Finance

What Should I Do if My 401K Stinks?

Advertiser Disclosure Comments 0 Comments

Q. I don’t think I have good investment choices in my 401K plan, but I’ve always saved the max. Does it make sense to save to an IRA instead and put the rest in some other kind of account where I can choose the investments? — Analyzing

A. There’s a lot to consider here.

If your employer offers a 401K and will match a percentage of your contributions, you should definitely take advantage of it, said Lisa McKnight, a certified financial planner with Lassus Wherley in New Providence.

She said most employers offer a matching contribution up to a certain percentage of your salary.

“For example, if your employer will match your 401K contributions up to 6% of your salary, you should always contribute at least 6%,” McKnight said. “That’s equivalent to a 100% return on investment.”

It would take years in an IRA to achieve that same 100% return, she said.

Over time, those contributions compound, leading to far more growth over the long term.

Next, consider taxes.

All the money you contribute to a 401K is pre-tax, she said. You are not taxed on that money during the year that you earn it. Rather, it is taxed when you withdraw it in retirement.

McKnight said in 2016, you can contribute up to $18,000 of pre-tax money to a 401K and if you are over 50, you can contribute an additional catch up contribution of $6,000.

She said saving to a 401K is easy and disciplined with automatic payroll deductions.

As you noted, in a company-provided 401K, you are limited to choosing among the investment choices, typically mutual funds, that the plan offers.

“While your company may give you information about the funds, you’ll need to figure out which ones are best for you,” she said. “Since you’re bearing all the risk, it’s important that you choose wisely.”

McKnight said although you are limited to the funds within the plan, you do have control over which ones and the types of investments to use.

These should be based on your risk tolerance and investment horizon, she said.

She said your employer may offer tools to help you familiarize yourself with the risk/reward relationships. You will want to familiarize yourself with your choices.

“There should be a few target date funds, stock and bond funds and blended funds,” McKnight said. “Within each of these categories, there should be a number of funds to choose from, each with a different investment strategy and level of risk.”

If you do not feel comfortable choosing your own funds, then a target date fund may be the way to go.

“Target date funds will align with retirement dates such as Target 2020, Target 2025, etc.,” she said “These funds invest more conservatively as you near your retirement date.”

Target date funds are great options for people who want to invest in a fund that will automatically adjust the overall risk level as they near retirement, McKnight said.

Even if you end up investing in a target date fund, you may still want to invest in some other funds to further diversify your portfolio, she said.

There are funds that focus on a wide variety of different investments, all with differing levels of risk. You will likely have options that include funds that focus on international stocks, emerging markets or real estate.

If you are more of a do-it-yourselfer and want to choose your own funds, she recommends you look for index funds.

Most plans will have a handful of index funds.

“Index funds are style specific, low cost and track the performance of various indexes, such as the S&P 500, Russell 2000 or the EAFE,” McKnight said. “If your plan offers several low cost index fund choices, perhaps an S&P 500 or total stock market index fund, an international stock index fund and a bond index fund there is enough variety to serve as the core of a diversified portfolio — the division of your funds between stocks and bonds.”

If you are stuck with choosing from investment options consisting only of actively managed funds, she suggests you pick the ones in each asset class with the lowest expense ratio.

“Avoid all funds that hit you with a sales charge,” she said.

Additionally, you will want to avoid company stock, she said. Some companies encourage the purchase of company stock in 401K plans, and they may even make matching contributions in company stock.

McKnight said you should avoid purchasing company stock.

“You are already invested because you depend on your company for your paycheck. It would be a financial blow if your company went out of business and you lost your job,” she said. “Don’t compound that risk by adding company stock to your 401K plan.”

Now let’s look at IRAs.

McKnight said if you have a poor 401K plan and your employer does not make any matching contribution, you may want to consider participating in a self-directed plan such as an IRA or Roth IRA, or you can save to both.

She said you don’t have to choose between an IRA and a 401K as long as you are qualified and you heed contribution and income limits.

Be aware that there are restrictions with IRAs and Roth IRAs such as contribution and income limits.

“If you are able to participate in an employer-sponsored plan, then the deductibility of your IRA contributions will be subject to income limits,” McKnight said. If your income is too high, you cannot deduct contributions.

In 2016, your ability to deduct contributions to a traditional IRA begins to phase out if you earn more than $61,000 as a single tax filer or $98,000 if you’re part of a married couple filing jointly.

Roth IRAs do not provide a tax deduction for deposits, but allow you to withdraw money tax-free in retirement, McKnight said.

There are income eligibility limits starting at $116,000 for single taxpayers and $183,000 for married couples filing jointly. Those with earnings less than the income limits are eligible to deposit up to $5,500 into an IRA or Roth IRA in 2016. Those age 50 and older are able to deposit up to $6,500 in their account for the year.

Those above the income limits can still contribute up to the maximum to an IRA, but lose the ability to deduct the contribution, she said.

One drawback of an IRA is that it doesn’t offer the same level of creditor protection as a 401K plan, McKnight said.

Another downside of IRAs is that the onus is on you to vet investment options, she said.

“Most 401K plans offer a limited number of investment options, whereas with an IRA you are open to a much larger universe of investments,” she said. “It is your responsibility to vet and choose wisely.”

McKnight recommends you be aware of high fees and avoid higher-priced commissionable products. Your IRA may end up being more expensive than it needs to be.

Despite these restrictions, an IRA does offer more freedom of where you want your money to go, McKnight said.

Both are great tax-advantaged ways to save for retirement.

“Regularly contributing to either one is a great way to grow your investments for retirement. The more you contribute, the more your assets can compound over time,” she said. “You should strongly consider maxing out your contributions, especially if they are eligible for an employer match.”

McKnight suggests you consider the following:

1. If your employer offers a company match, then first fund your 401K up to the point where you get the maximum matching dollars.

2. Direct the next investing dollars to an IRA — a traditional IRA for upfront tax deductions or to a Roth IRA to get a tax break in retirement when you start making withdrawals.

3. After maxing out the IRA, return to your 401K plan to take advantage of the higher contribution limits and the higher current year income tax break.

Image: grinvalds

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other articles on Credit.com News & Advice may also be offered through Credit.com product pages, and Credit.com will be compensated if our users apply for and ultimately sign up for any of these cards or products. However, this relationship does not result in any preferential editorial treatment.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Our Owners

Credit.com is owned by Progrexion Holdings Inc. which is the owner and administrator of a number of business related to credit and credit repair, including CreditRepair.com, and eFolks. In addition, Progrexion also provides services to Lexington Law Firm as a third party provider. Despite being owned by Progrexion, it is not the role of the Credit.com editorial team to advocate the use of the company’s other services. In articles, reporters may mention credit repair as an option, for example, but we’ll also be sure to note the various alternatives to that service. Furthermore, you may see ads for credit repair services on Credit.com, but the editorial team isn’t responsible for the creation or implementation of those ads, anymore than reporters for the New York Times or Washington Post are responsible for the ads on their sites.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team