Updated: Apr 02, 2024

What Makes a Bad 401(k) Plan?

Learn about the different factors that make up a bad 401(k) plan, including fees and investment options.
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An employer-sponsored 401(k) retirement plan is usually an excellent retirement vehicle, and for many people, it is the primary way they save for retirement.

Many financial experts will tell you that you should set aside part of your income in tax-advantaged retirement accounts, such as your 401(k) account, if you have one, or individual retirement accounts.

But not all 401(k) plans are the same.

Your company’s 401(k) plan may not be the ideal retirement savings option.

But as we will repeat several times in this article, a bad 401(k) is no excuse to not save for your retirement or to put off saving for your retirement.

Different Types of Employer-Sponsored Retirement Plans

There are two main types of employer-sponsored retirement plans, defined benefit retirement plans, usually referred to as pension plans, and defined contribution plans, usually referred to as 401(k) retirement plans.

There are also 403(b) plans, usually offered by non-profit organizations, churches, school districts and government organizations.

Because 403(b) plans are very similar to 401(k) plans, for the purposes of this article we will refer to defined contribution plans as 401(k) plans.

What Makes a Bad 401(k)

Although an account may be designed to help you sock away money toward retirement, it doesn't mean the account is 100% looking out for you.

These are the biggest reasons that your 401(k) isn't treating you right.

1. No company match

Many employers that offer a 401(k) plan include a company match.

For example, if you set aside 4% of your paycheck before tax, your employer will “match” part of that amount and put that in your 401(k) account.

This is free money and generally, you should contribute at least the highest amount of your paycheck to get the highest offered match.

A popular benefit is to match 50% up to a certain percentage of your pay.

For example, if you make $100,000 and contribute 4% or $4,000, your company would match 50% of that money, or $2,000, giving you a total of $2,000 in “free money”.

Take a look at your company’s “vesting schedule” – because the money that your company matches to your 401(k) account may not be yours right away. You may have to work at the company a certain number of years to be entitled to the matching funds. Or you may receive 20% each year over a 5-year period.

2. Administrative fees

Administrative fees are charged by the company managing the 401(k) for your employer.

As a general rule, if you are paying fees of more than 1 percent a year, you are paying too much.

If you have $20,0000 in a 401(k) account, and your investment expenses are 1.58%, you are paying $15.80 per $1,000 invested, or $316 per year.

If your 401(k) fees are higher than 1%, see what other lower cost investment options are available.

It is possible that the default option is a higher fee, and there are lower fee options available. The higher your balance in your 401(k), the more you’re paying in fees.

3. Expensive and/or limited investment options

Another reason that a 401(k) isn't up to par is when you don't have access to investment choices that you'd like.

Maybe you prefer the index funds from a particular mutual fund company. Or, you'd like to invest in target-date funds, but they're not offered.

Additionally, your options may be limited to funds that carry high expense ratios.

The expense ratio is the percentage fee charged by the mutual fund. It is deducted from the amount invested.

Why You Should Still Use the 401(k)

Really, the main reason you should consider NOT investing in a 401(k) is if your company does not offer a match.

But this does not mean you should not save.

If your employer offers a 401(k) savings plan but does not offer a “match” on your contribution, you may look closer at the administrative fees and investment options and see if they make the most sense for you.

There are several reasons you may still want to use a company offered 401(k) plan, even if a match is not offered:

  • You save automatically: You’ll have regular deductions from your paycheck going into a savings account. You won’t even see this money, and it will be saved for you. You won’t have the chance to consider spending it on something else.
  • You pay less income tax: Contributions to a 401(k) plan reduce your annual taxable income. If you make $50,000 a year and put $8,000 into a 401(k), you only pay tax on $42,000.
  • Your money is safe from creditors: Thanks to the Employee Retirement Income Security Act of 1974 (ERISA), if you lose your job, go bankrupt, and lose your house, the lender can get a judgment against you and your savings account, but not your 401(k).

If You Have Debt

If you are paying off credit card debt or student loans, you should still put money aside for retirement in an IRA.

And if you have no savings, you should set aside $1,000 in an emergency fund.

Ideal Size of an Emergency Fund

To start... Ideal goal... Super safe...
$1,000 3-6 months of essential expenses 12 months of expenses

You should not touch this money unless absolutely necessary.

An emergency fund should protect you from ever having to dip into retirement funds and pay high fees for early withdrawals.

Talk to a financial advisor, or a mentor you trust, about your best plan for paying off debt and saving for retirement at the same time.

What to Do If You Don’t Have a 401(k)

You may be in an employment situation where a 401(k) isn’t available.

Perhaps you are an assistant for a solo practitioner attorney, or work as a nanny for a family, and a 401(k) isn’t offered. Or maybe you’re a self-employed blogger.

If you have a job you love and good income, but a retirement plan isn’t readily made available, this isn’t a reason to stop doing what you’re doing.

But you also shouldn’t neglect saving for your retirement, even if you’re in your early twenties.

Although you can invest in mutual funds or a taxable brokerage, these do not have the tax advantage of an IRA.

If you are saving for your retirement and not something else (such as a car, a home, or financing your child’s education), putting money in an IRA is the way to go.

If You’re Self-Employed

If you have freelance income, you can open a SEP Ira. One of the great things about a SEP IRA over a traditional or Roth IRA is the elevated contribution limit. You can save more!

In 2021, the maximum contribution for a SEP IRA is $58,000 per year.

You can also open a one-participant 401(k), or solo 401(k), a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse

Saving for Retirement with an IRA

An individual retirement account, or IRA, is a good option for anyone that doesn’t have a company-sponsored retirement plan.

Setting money aside each month may take a little more discipline than a 401(k) contribution, as it won’t automatically come out of the top of your paycheck.

If you are under age 50, you can save $6,000 per year in an IRA.

If you let that $6,000 grow for 30 years and earn at 7 percent annualized return, you will have saved more than $45,650. Set aside $6,000 every year, and you’ll be well on your way.

There are two main types of IRAs, both with unique advantages.

Traditional IRA Vs. Roth IRA

Traditional IRA Roth IRA
Contributions may be tax-deductible. Contributions are not tax-deductible.
Pay taxes upon withdrawal. Earnings can be withdrawn tax-free and without penalties if the funds were in the Roth IRA for 5 years and you've reached age 59 1/2.
You must be under age 70 1/2 to contribute. You can contribute at any age.
Required minimum distributions (RMDs) are required starting at age 70 1/2. No RMDs required.

Traditional IRA

With a traditional IRA, you pay taxes on your money when you make withdrawals on the funds in retirement.

When you file your tax return, you may get a deduction on your tax filing. If you touch the money in your IRA before you retire, you will pay regular income taxes on the full dollar amount.

And if you are under age 59½ when you withdraw your money, you will also have to pay a 10% penalty in addition to paying your regular income taxes.

You must start withdrawing the money when you turn 70 ½ (unlike a Roth, where you can leave the money as long as you want).

Roth IRA

A Roth IRA is a type of savings account where you contribute after-tax dollars but do not get any tax break on your tax return filing.

But when you withdraw money after you retire, there are no taxes. Every penny is yours.

With a Roth IRA, your contribution is limited by income level. If you expect to be in a higher tax bracket when you retire, a Roth IRA may be for you.

Talk to Your Employer About Retirement Planning

If your company does not offer a 401(k) plan, talk to your HR manager, and encourage your coworkers to speak up as well.

If you do have a 401(k) plan, it is still worth bringing up that you're not getting the options that you'd like.

It might be all that it takes for your employer to review its 401(k) plan and switch to a new company to manage the benefit or change up the investment choices made available to participants.