Contributing to your 401(k) is a great way to save for your retirement. The media often touts that you should save first in your 401(k) up to the match, then maybe a Roth or regular IRA, followed by maxing out your 401(k).
I’d say this is good advice most of the time and that is what the media shoots for. However, there are some unique situations where investing in a 401(k) isn’t one of the best options. Believe it or not, there was a time I didn’t invest in a 401(k) for some of the reasons below!
401(k) Offers No Match or Automatic Contribution
It may make sense to skip investing in a 401(k) if your 401(k) offers no employer match. Why? Normally the greatest benefit of a 401(k) is the matching contribution from your employer. No matter how your contributions are matched (dollar for dollar, 50 cents per dollar, 25 cents per dollar, etc) your match is essentially free money and it likely provides one best returns on any retirement investment you could make.
Without the 401(k) employer match, a 401(k) is just another retirement vehicle like many others. It still offers tax advantages, which are awesome, but there are other restrictions that make the 401(k) not quite as flexible as savings vehicles such as IRAs.
Lack of Flexibility and High Fees
Your 401(k) must be held with the institution picked by your company and can only have investments that are part of the plan. Some of these investments will not be suitable for your particular needs and some unfortunately have high investment fees as well. If you have no employer matching, the inflexibility and fees can easily make the 401(k) a vehicle you want to skip until your other options are maxed out.
In fact, a recent piece by My Journey to Millions points out how outrageous these fees can be. His only cash fund option charges 0.95% in fees just to hold his investment in cash. CRAZY! Those aren’t the only fees. Make sure you watch out for record keeping, quarterly and other annual fees your 401(k) might charge.
Your Employer Contribution May Be Automatic
My employer contribution at a previous job was automatic and would be placed in my 401(k) regardless of whether I contributed or not! Talk about awesome! If this is the case for you it may make sense to max out your IRA before you contribute a dime of your personal money into your 401(k). If you have better options in your IRA than you do in your 401(k) and this is the case I say go for the IRA!
Your Vesting Schedule is Horrible
The last reason I can think to skip contributing to your 401(k) is if your vesting schedule is absolutely awful and you plan to leave town before you would vest at all. Vesting essentially means that if you left your job today you’d get to keep all or part of the employer contribution to your 401(k).
This reason to skip investing in your 401(k) is a bit trickier as you’d have to know 100% that you’re going to be leaving town before you vest in any of your employer match. If your spouse is in the military it may be the case though. If you end up not leaving when you plan or expect you’d be leaving free money on the table… We don’t want that!
Why I Didn’t Contribute to a 401(k) in the Past
As I mentioned above, my previous employer’s had a 100% automatic contribution to my 401(k) regardless of whether I contributed anything to my 401(k) or not. The 401(k) didn’t have the best investment options so I opted to max out my Roth IRA instead. If I had gotten to the point where my Roth IRA was maxed out I would then contribute to my 401(k) but I ended up changing jobs before that happened.
Have you ever not contributed to a 401(k) for one of the reasons above? How about another legitimate reason?