Saving for retirement is super important provided you don’t want to be 78 and eating Alpo. While you have been paying into social security your whole life and you might even hold a unicorn pension, it’s important to save enough on your own in case these don’t come through for you. An employer sponsored plan, or a 401(k) may be a great option, but it isn’t always the best choice. Let’s examine when you may not want to contribute to your 401(k).
1. Your employer doesn’t offer a match.
One on the major draws of a 401(k), along with automatic payroll withdrawals, is the match that your employer offers up to a certain percentage. For example, your company’s policy may say that your contributions up to 3% of your income will be matched by the company. This is an awesome incentive!
However, if your company does not offer such a match, there is little reason to contribute. As we will discuss later, other options may be preferable because they offer better investment options, lower fees, and Roth options.
2. You are in a large amount of high interest debt.
Compound interest can be a blessing or a curse, depending on which side you’re on. Investing for retirement can help your money grow rapidly, but it is often a smaller return than you would get from paying off high interest debt.
For example, if you have a credit card with 18.99% interest, you will be hard pressed to find investments that do quite so well. It is generally a good idea to knock out all high interest debt before moving on to investing.
3. You don’t have an emergency fund.
Retirement accounts are great…when you are in your sixties. For now, you need liquidity in the event of a rainy day. Spoiler alert: there WILL be a rainy day. Having an emergency fund should be your number one priority.
If your car broke down tomorrow, would you be able to pay for repairs without going into debt? Build an adequate emergency fund for unforeseen costs before contributing to your retirement fund. A good rule of thumb is saving enough to cover all non-medical deductibles and plane tickets home if you live far away from family. After this savings account is funded, you can start saving for retirement.
4. You don’t like your employer’s investment options.
Most companies have a committee that evaluate and choose a limited amount of funds for the employees to invest in. While hopefully this committee is competent, you may not be satisfied by the type of funds or their long term performance.
With an IRA, you are free to choose whichever investments you would like in your portfolio. It puts you in complete control of your retirement savings and allows you to branch out if you don’t like the 10 or 15 funds your employer plan is allowing.
5. Your employer’s 401(k) does not have a Roth option.
While many employers are adding a Roth option, others only offer a traditional. What does this mean?
- Traditional 401(k): Contributions are tax-free, distributions and earnings are taxed.
- Roth 401(k): Contributions are after tax, distributions and earnings are tax-free.
So why would you contribute to one over the other? Well a Roth is preferable if you believe that you will be in a higher tax bracket in the future and you want your earnings to grow without taxation. It’s an awesome option for a large amount of people, particularly millennials. Millennials, or members of Gen Y, have a long time to allow their savings to grow and will most likely be in a higher tax bracket at retirement.
While traditional is a solid option for decreasing your tax penalty now, your distributions (including earnings) will be taxed in the future. For those that prefer a Roth option, you may want to stick with an IRA if Roth 401(k)s are not currently offered by your company.
6. Your 401(k) plan has high fees.
Who wants their retirement contributions to be eaten up by fees? No one, that’s who! If your employer sponsored plan has high fees, you may want to consider an IRA.
With an IRA, you can choose your own discount broker with low fees. Your 401(k) does not allow you such options as you can’t shop around for the cheapest brokers. Your employer will choose who you invest with. If your fees are too high, you might not want to use a 401(k).
7. You don’t plan on staying with your company for the long haul.
Even if your company does offer an employer match, it may not be in your best interest to go with a 401(k). For starters, most matches are on a vesting schedule. For example:
- 20% vested after 1 year
- 40% vested after 2 years
- 60% vested after 3 years
- 80% vested after 4 years
- 100% vested after 5 years
If you plan on staying less than a year, it is pointless to contribute. Even after a year or 2, is the 20% or 40% of the 3% match really worth the headache of rolling that plan over into an IRA when you leave?
That’s right, when you leave you have to decide what to do with the account. You can:
- Keep it there if it is a certain size — Not recommended.
- Leave it and allow it to be rolled into an IRA with the same brokerage firm — Fine, if that’s the discount broker you want to go with. However, this is not a great idea if there are high fees.
- Have it distributed to you — NO, don’t do this. Ever, ever, ever. Taxes and penalties will absolutely eat your contributions up.
- Get it rolled over into a 401(k) at your new employer — Not ideal because the best part of a 401(k) is the match.
- Get it rolled over into an IRA at the discount broker of your choice — Yes, this option is the best. It also means paperwork.
8. You need a large amount of cash. Soon.
If you are planning on buying a house in the near future and need to save up a down payment, you may want to postpone retirement contributions for a short period of time. Note: short period of time. Do not put off retirement savings for too long. Time is money, baby.
Word of warning: DO NOT put off retirement savings to save for your kids’ college education. I know that you don’t want them to be burdened with student loans, but there are no student loans for retirement. It will be a bigger burden when they have to take care of you in your old age because you failed to save.
Do you contribute to an IRA, a 401(k), or both? What are a few reasons that you wouldn’t want to contribute to your 401(k)?