Few resources are better for financially preparing you for retirement than a 401(k) plan. It's a win-win: You save money in the present by lowering your taxable income, and you also set yourself up for future financial stability.
However, like most money-related things, they're pros and cons to a 401(k).
Here's the unfortunate truth about maxing out your 401(k).You're likely paying more in fees than you realize
One thing many people are shocked by is just how much they're paying in fees for their 401(k). People face three main types of 401(k) fees: administrative, investment, and service.
Image source: Getty Images.
Administrative fees are charged by your plan provider to cover the cost of maintaining your plan. In some cases, they can be as much as 2% of your invested amount. Investment fees (essentially expense ratios) are charged by whatever fund(s) you invest in. If you're invested in four different index funds, you'll pay the investment fee for each fund. Service fees are based on additional services you may opt into, such as taking out a 401(k) loan or financial advisory services.
Here's approximately how your account value would differ by fees if you invested $500 monthly for 25 years, averaging 8% annual returns:
| Total Fees | Value After 25 Years | Amount Paid in Fees |
|---|---|---|
| 1% | $379,494 | $59,141 |
| 1.5% | $353,326 | $85,309 |
| 2% | $329,187 | $109,448 |
Data source: Author calculations.
A 0.5% difference in fees may look insignificant on paper, but over time, it can really add up and cost somebody well into the five-figure range.
A relatively small 1% difference in our example led to more than $50,000 paid in fees over 25 years. In short: Fees matter, so don't overlook them.You could have a broader range of investment options
There are many great things about a 401(k), but unfortunately, the investment options aren't normally one of them. With your 401(k) plan, you can't invest in any stock you want; your options are provided for you. Generally, you have three broad options: your company's stock if it's a public company, market cap-based index funds, and target date funds that automatically rebalance to become more conservative as you near retirement.
Some investors find the limited options work in their favor because they'd prefer not having to decide between hundreds or thousands of stocks. For others, the limited options work against their preferred hands-on investing style. For example, if you wanted to invest in Apple or an industry-specific ETF like the Global X Robotics & Artificial Intelligence ETF in your 401(k), you likely couldn't.
However, this isn't the case with a retirement account like an IRA. IRAs operate like regular brokerage accounts in that you can invest in any stock you please. Whether it's Apple, an AI ETF, or whatever else, you're free to invest there. With a Roth IRA, you contribute after-tax money and then receive tax-free withdrawals in retirement. Contributions to a traditional IRA may be tax deductible, depending on your income and filing status.
It's only realistic for a few people
In theory, maxing out your 401(k) sounds like a great thing that everyone should aspire to do. In reality, it's just not realistic for most people. For tax year 2023, the maximum contribution to a 401(k) plan is $22,500 ($30,000 if you're 50 or older) — roughly one-third of the median U.S. household annual income.
You want to save as much as possible for retirement, but you don't want to put your current livelihood at risk to do so. If you have the means to max out your 401(k), by all means consider it. If you don't, that's perfectly fine, too. At the very least, assuming you have the means, you want to make sure you're contributing enough to get your max employer match.
Contributing anything less than what your employer will match is essentially leaving “free” money on the table. For example, if you make $100,000 and contribute 3% to your 401(k), even though your employer matches up to 5%, you'd be missing out on an additional $2,000 each year. Your future self will thank you for taking advantage.
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