Is it worth it to contribute to my company's 401k?
July 21, 2012 3:36 PM   Subscribe


I recently joined a new company, and I'm leery of contributing to my 401K since I've read quite a few bad reviews about John Hancock's fees, even for index funds. It seems that they can be anywhere from 2-5%. Since we don't get an employee match, I would definitely be eating a lot of those hidden fees myself.

However, I'm aware of the tax advantages, and I'm really far behind on my retirement savings plan. I'm nearly 32 now, and I basically only have about roughly 4K in a Roth IRA and a Certificate of Deposit.

Some pertinent info: I make about 55K before, 41K after taxes, and I live in California. I'm trying to save up about 1/3rd of my salary after taxes for retirement.

If I don't contribute to my company's 401K plan, what are some alternatives?
You would have to do the math yourself, but there are definitely 401(k) plans out there that are bad enough that you wouldn't want to contribute, even with the tax advantages.

If you want to contribute 1/3 of your salary after taxes to retirement, that's roughly $13500 of your 41K salary.

Definitely contribute the maximum every year to a Roth IRA-- that'll take care of your first $5K/year of retirement savings.

For the remaining ~8500, you have two nonideal options: Contribute to the 401(k), or invest in index funds, which are amazingly tax-efficient.

You would have to do the math yourself based on your tax rates and exactly how bad the 401(k) is, but here are the pros and cons:

-Cons: huge fees; money is restricted so you can't take it out prior to retirement (actually, may be a pro or a con for you)
-Pros: Tax-deferred; if you ever change jobs, you could roll it into either a better 401(k) (if one was offered at your new job) or else a low-fee IRA

Tax-efficient index funds
-Cons: Not tax-deferred, you would have to pay taxes on them every year. You ONLY pay taxes on your gains, and you only pay taxes if the manager of the funds actually sells stocks, and most try not to do that. Look into Vanguard, they keep the losses due to taxes very, very low
-Pros: You can do whatever you want with the money, fees are extremely low

In a similar situation, I decided to go with the index funds. I don't know if it was mathematically the right decision, but it made sense for my situation.

A third option would be tax-free municipal bonds, but I don't know too many details on those-- I think they only shield you from state taxes, and at your age you probably don't want a ton of bonds in your portfolio anyway (unless you do, in which case they may be something to investigate.) IMHO I would _not_ be buying California municipal bonds right now, though. I heard recently about two or three California municipalities going bankrupt; I know that stocks have risk too, but California bonds are probably riskier than I'd want to invest in for the rate that you'll probably get.
posted by matcha action at 4:19 PM on July 21, 2012

Sorry, one last thought--
If you post your question on the forum at you will definitely get some good advice on the topic. The forum members are extremely tax-savvy and they will know how to figure out which is the best option for your situation. Wait until you actually get your 401(k) packet though so you can post the details of the particular funds offered and the associated fees; sometimes even a bad plan will have a good option or two, in which case you'd want to invest only in that in your 401(k) and then balance the rest of your portfolio using your Roth IRA.
posted by matcha action at 4:24 PM on July 21, 2012

With no match and the limited investment options in a 401(k). I'd put my money in a Roth Ira in an exchange traded fund (lowest management fees). I like the Spider, but pick one you like.
posted by Ruthless Bunny at 6:30 PM on July 21, 2012 [1 favorite]

You should check to find out the exact fees before making a decision.

You should obviously put your first $5000 of savings into a your IRA.

After that it depends. Keep in mind that if you leave your current employer, you can take whatever you have in your 401k and roll it into your personally managed IRA for the rest of your life. So if you think you may be changing jobs in the next five to ten years, it still might make sense to sock away as much as you can into your 401k and then roll it into your IRA when you change jobs. If you don't put money in your 401k, each year you give up that one time opportunity to put savings into a tax advantaged account forever. It may be worth even ten years of high fees in a 401k in order to have another 40 years of tax deferral in your IRA.

Another, somewhat complicated thing you can do is put money into your 401k and then take out a loan from your 401k. You can borrow up to $50,000 or 50% of the balance. You take the money from the loan and invest it some other tax advantaged plan like a 529 for kids education where you can use funds with lower fees. This only makes sense if you have other tax deferred accounts you otherwise wouldn't fill. Essentially all you are doing is borrowing from a bad tax deferred account so you can invest in a better tax deferred account. It is all still your money.
posted by JackFlash at 10:33 PM on July 21, 2012 [1 favorite]

A traditional IRA offers exactly the same tax advantages as a 401k. My brokerage of choice is Fidelity despite the fact that I work for a large bank with their own brokerage company. There aren't a lot of fees and you have access to more mutual funds than you can shake a stick at.

Max out your IRA contributions before enrolling in the 401k.

It sounds like it isn't so much a problem with the 401k itself as it is with the funds that you can select to invest in. The 401k is just an investment vehicle, not the investment itself. It's like moving cargo, the type of semi-truck is the 401k, Roth IRA, Traditional IRA, or non-retirement investment , the cargo it carries is the actual fund (IE, index fund, stable value, or whatever. You can use different vehicles to carry different cargo but the vehicle's pros and cons are distinct from the pros and cons of the cargo.

Without the company match, a traditional IRA is basically the same vehicle as a 401k except that you have a $5,000 annual contribution limit to the IRA whereas the 401k limit is $17,000. The IRA will let you carry any cargo you want while the plan administrator usually limits you to a dozen different options.

Has anyone complained to your company's HR department about the funds that the 401k offers? If enough people ask about it they might look at changing the investment options in the plan to some funds with lower expense ratios.
posted by VTX at 5:35 AM on July 22, 2012

Oh, and don't consider a CD to be part of your retirement savings until you're a few years from retirement. They are for short-term low-risk investing only and aren't much different than a regular savings account.
posted by VTX at 5:37 AM on July 22, 2012

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