After sharing my last post about the average 401(k) balance for Americans, I’ve received several questions from people wondering if they really needed to contribute to their retirement accounts. So I thought it would only be fair to share some of the reasons why you shouldn’t invest in your 401(k).
Without even asking anyone, you’ve probably heard the good and bad about a 401(k). Some people will tell you it’s one of the best ways to save for retirement, while others will shake their heads vigorously no and plead you don’t sink your money into it.
So which one is it? Do you use it to save for retirement or pass on it to find some other ways to save? We’re telling you to PASS for the following reasons:
Many reasons exist for not contributing to your 401(k). Most of them have to do with your financial situation. There are other financial moves you should make before even thinking about a 401(k), and for some people, it’s never a good idea to use it.
- You’re Up to Your Ears in Debt
A 401(k) will do you no good if you’re swimming in debt. It’s more important to take the money you were going to put in the retirement fund and use it to pay debt. When and if you pay off that debt, you may want to reconsider the 401(k), unless you have the following case.
- Your Employer Isn’t Matching the Contribution
Not all employers will match 401(k) contributions, which means if you put $500 into it, your company isn’t putting another $500 in it. That’s bum luck for you, and it’s really the only advantage to a 401(k). It’s best to forego the 401(k) and choose another type of retirement fund if you’re in this situation because the risks of it don’t necessarily outweigh the benefits.
- You Don’t Have an Emergency Fund
While you may think you’re doing a good job with saving when you put a lot of money toward your 401(k), it’s not the best move if you don’t have an emergency fund. This fund protects you in case of … well, emergencies.
Let’s say you lose your job tomorrow. How will you pay your bills? How will you eat? You’ll need money for all of those things, and if you don’t have an emergency fund, you’re going to be stuck. You can dip into your 401(k), but that’s not the best idea because you’ll have to pay penalties. That could end up wiping your account out and you’ll still not have enough money to survive.
The best thing to do is save up some emergency cash first. Experts say you need about six months’ worth of expenses, which means if you spend $5,000 a month, you need $30,000 in your emergency fund.
- The Taxes May Be Huge When You Retire
What people love about the 401(k) is you get to save money that isn’t taxed yet. You only pay taxes when you withdraw the money at retirement. The problem is you have no idea what taxes are going to be like when you retire.
Right now, the highest tax bracket is just below 40%. This may sound high, but if you look at what it was in the past, it’s actually low. Could you imagine if the tax bracket shot up to 60% or more when you retire? You would have to pay 60% of the amount you withdraw. That’s a huge cut! Taxes are historically low compared to the days 60%, or even 90% marginal rates of the past. Considering our record with national debt, this probably means that taxes will only go up.
On the other hand, it could be lower, maybe only 30% when you retire. That would be great. However, there’s no way to know what’s going to happen, so you’re taking a huge gamble when deciding to contribute to a 401(k).
- You Lose More Money with Fees, also, Curse You Compound Costs
When you contribute to a 401(k), you shouldn’t touch the money until retirement. If you do, you’ll end up paying a hefty penalty fee. While this makes sense, there are even fees if you wait until retirement. When you’re ready to withdraw your money, you could end up paying administrative fees, individual service fees, sales charges and management fees. The funds inside the 401(k)s usually take a 2% fee off the top. So if a fund is up 8% for the year, they take 2% while you keep 6%. The founder of Vanguard, Jack Bogle explains this as, “What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compound costs.”
When you consider the fees with the possible high tax bracket, you may end up with just a few thousand dollars. That could be highly disappointing, especially if you don’t have retirement savings elsewhere.
Think long and hard about using a 401(k) for retirement savings. If you have an emergency fund, no debt and your employer matches your contribution, it’s probably worth it. If not, try something else as long as you make sure to do the research.
How are you saving up for retirement? Do you agree with the reasons why you shouldn’t contribute to a 401(k)?