Thursday, March 21, 2013

Should You Invest in a Bad 401(k) or 403(b)? @ Financial Ramblings

I?ve been fortunate. Over the years, my employers have offered excellent retirement plans. But for many, that?s not the case.

If your 401(k) or 403(b) plan stinks ? due to high fees, lack of appropriate investment options, or both ? what should you do?

Should you still contribute? Or should you just fund an IRA and then move on to investing in a taxable account? Today I want to take a closer look at the options and offer some suggestions.

For starters, your retirement plan at work offers two main advantages:

  1. additional tax-advantaged investment space, and
  2. the possibility of matching contributions.

Currently, IRA contribution limits stand at $5,500/year, whereas 401(k) and 403(b) contribution limits are $17,500/year. So your limits at work are more than 3x higher. That?s a pretty nice option to have.

Of course, you can do both. So? Ignoring catchup contributions, this gives you the ability to stash a combined total of up to $23k/year in tax-advantaged accounts.

As for employer matches, many plans will match 50%-100% of your contributions up to a certain level. This is free money, and you should almost always take it.

In very general terms, when thinking about long-term (retirement) savings, I would prioritize things like this:

  • Fund your retirement plan at work up to your employer?s match
  • Max out your IRA (traditional or Roth, depending on your circumstances)
  • Go back to funding the employer plan up to the limit unless it?s truly horrid
  • If you?re still looking to invest, continue to do so in a taxable account

So? Once you?ve captured the matching funds, I would lean toward switching to an IRA as this gives you absolute control over your money. From there, I would likely switch back to the employer plan up to the max due to the tax benefits.

As for what constitutes a ?truly horrid? plan, that depends on a number of factors (tax brackets, type of investments held, etc.) ? but I would likely tolerate at least 0.50%-0.75% in added costs in exchange for the tax benefits.

If the investment choices are limited, you can always settle on the ?least bad? and then balance things out in other accounts. Remember, when allocating your portfolio, you should look at the whole pot of money vs. trying to hit the proper allocation within each individual account.

As for the traditional vs. Roth debate, please see my earlier discussion of tax diversification. The benefits of tax diversification apply to both you work-related retirement plan and your IRA(s).

Another consideration: If you ever change employers, you can roll your retirement plan into an IRA and extricate yourself from whatever negatives you?ve been dealing with. Thus, you may not be stuck with those high fees or limited choices for life.

Just keep in mind? If you?re planning on retiring between ages 55 and 59.5, it?s better to have your money in a 401(k) or 403(b) than an IRA because you can take distributions without incurring an early withdrawal. With an IRA, you have to wait until 59.5 (or jump through other hoops) to avoid the penalty.

Note: Just so you?re aware, much of the discussion above applies equally well to 457(b) plans. However, these rarely offer matching contributions so I?d be less likely to put them at the top of the list.


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