Prudent Money
Is the 401(k) Plan Really Worth it?  E-mail

A recent study shows a change in the way that companies are approaching 401(k) plans. The typical 401(k) plan is set up to where employers will provide a $0.50 on the dollar or a dollar for dollar match to any contributions by the employee.

Well, things have changed since the start of the credit crisis and recession. Similar to most recessions, employers will suspend the employer matching contributions program until the economy starts to rebound.

This time, 401(k) consultants say there is a different response. Consultants are reporting that their clients are either stopping the matching program altogether or making the match available to employees only on the basis of profitability of the company. In other words, if the company makes money, then the employee gets the match.

This current environment has really made employers rethink the matching contributions program. So does it make sense to keep investing money into a 401(k) plan?

If your 401(k) plan doesn't have a match, I would argue that it makes no sense to continue investing into it. The employer match (or free money as I like to call it) is the biggest benefit of a 401(k) plan.

Beyond that, there are more cons than pros to a 401(k) plan.

1) Lack of Investment Choice - Most 401(k) plans do not have enough choices for investment. I have looked at 401(k) plans with as little as 5 investment funds available for investment. That is clearly not enough diversity. Even if the plans have plenty of funds, they don't have enough different types of funds. They might have 10 stock funds and 4 bond funds. That can be problematic since bonds and stocks can both lose money at the same time.

2) Lack of Secure Investments - Most 401(k) plans at least have a money market; however, some do not. The good plans have a stable value fund. Beyond that participants have to rely on bond funds which are not secure.

3) High Expenses - When it comes to expenses, you don't have a choice. You are stuck with those high built-in 401(k) plan expenses. With any 401(k) plan, there are a lot of people receiving fees. That is all built into the hidden expense ratio.

What Is The Alternative?

If possible, max out an IRA or a Roth IRA. That will at least get you some tax benefits. Obviously by not investing in a 401 K plan you do forgo a much larger tax deduction. . However, with an IRA you can still get at least the maximum amount for that year in tax deductions.

As a rule of thumb, I don't recommend basing your investment decisions on tax savings.

What if you were investing more than $5,000 or $6,000? You would then consider opening up an investment account and saving into that account with the additional money.

Having money in a taxable investment account can be a very prudent way to save. Plus that money can be used for other financial goals or even emergencies. 401 K investing is all LONG-TERM. What happens if you need the short-term?

You have two other advantages by investing in an IRA and or other investment account. First, you have at your disposal a selection of all of the categories of investments available on the market. You can also control expenses more effectively with an outside plan based on the investments that you choose. Most importantly, you can have your IRA managed for risk and growth. That is a big deal. The best you can hope for with a 401(k) plan is a buy and hold strategy which has proven to be fatal for your account values.