It may seem counterintuitive, but stashing funds in your retirement plan at work could actually make it harder to retire. Some worktops are great while others are expensive and stiff. And some plans may be good for some employees, but not for you. So how do you know if your work plan is worth contributing? Keep reading to find out.
Signs you have a bad retirement plan
A bad retirement plan is one that severely limits your ability to make a profit on your savings. This can happen in several ways. First, your retirement plan may offer a poor selection of investments that are not suitable for you. If you invest too conservatively, your savings won’t grow as quickly and you’ll have to contribute more of your own money to save enough for retirement. If you invest too aggressively, you risk a significant loss that you may not be able to recover from when you retire.
Some investments can also be bad simply because they have high fees. Most 401(k), for example, give you the choice of a handful of mutual funds selected by your employer. All mutual funds have an expense ratio or annual fee that you must pay. It’s a percentage of your assets, and it can range from less than 0.5% for some index funds to more than 1.5% for some actively managed funds. The amount you actually pay depends on the amount you have in your account. For example, if you have $1 million in a mutual fund with a 1% expense ratio, you will pay $10,000 per year. Keeping your expenses as low as possible helps you save more money for your retirement.
Pension plans also have other fees, which cover things like record keeping and one-time actions like account transfers. These costs vary by plan, although larger companies are usually able to offer more affordable pension plans because they can spread these costs across multiple employees.
There is no hard and fast rule for what is considered a high cost pension plan. You have to decide for yourself what you are comfortable paying. But if you’re giving away more than 1% of your assets in fees each year, it’s worth exploring other options to see if you can do better elsewhere.
A company matching contribution can help buy out an expensive workplace pension plan, assuming the consideration you earn is enough to cover what you pay in fees. But you have to consider the acquisition schedule. This dictates when you keep your match if you leave the company. If you don’t plan to stay until you’re fully invested, you’ll lose some or all of your match. In this case, you need to consider the value of your workplace pension plan outside of the matching contributions it offers to decide if it’s right for you.
Alternatives to your workplace pension plan
Whether you think you have a good workplace retirement plan or not, it’s worth comparing it to some of these other retirement savings accounts before deciding which one is right for you right now.
An IRA is a popular alternative to workplace retirement plans because anyone can open one with any broker. There are also fewer limits on what you can invest in. This gives you more freedom to choose affordable investments that match your risk tolerance, which could help you grow your nest egg faster than you could with your work plan.
The biggest downside to an IRA is that you can only contribute up to $6,000 in 2021, or $7,000 if you’re 50 or older. That’s less than a third of the $19,500 you can contribute to a 401(k) in 2021 ($26,000 if you’re 50 or older). So if you plan to contribute a lot in your retirement this year, you may need to link an IRA to a different type of account.
Health Savings Account (HSA)
Although not technically a retirement account, a Health Savings Account (HSA) does the trick. Your contributions reduce your taxable income for the year, just like traditional IRA and 401(k) contributions. Plus, there’s the added bonus of tax-free withdrawals on medical expenses, regardless of your age. Some HSAs also allow you to invest your funds as you would with a retirement plan.
The catch is that you must have a high-deductible health insurance plan to contribute to an HSA. It is one with a deductible of $1,400 or more for an individual or $2,800 or more for a family. If you meet these criteria, you can set aside up to $3,600 in an HSA if you have an individual plan or $7,200 if you have a family plan in 2021.
Taxable brokerage account
Taxable brokerage accounts are also not retirement plans, but they allow you to invest your money without restriction and you can withdraw your funds at any time without fear of penalties. You don’t get the same tax breaks as with a retirement account. You pay tax on your contributions in the year you make them and you will also have to pay tax on your earnings. But if you hold your investments for at least a year, they become subject to long-term capital gains tax, which can save you money compared to paying tax on the same amount.
You don’t have to limit yourself to just one account
If you’re hesitating between two types of retirement accounts, you can always put money in both. Or start with one and move on to another if you max out the first. For example, you can start saving in an IRA and then switch back to your occupational retirement plan if you reach the IRA’s annual contribution limit for the year.
The right solution ultimately depends on your workplace pension plan, your financial situation and your long-term goals. These things can change from year to year, so remember to set aside time each year to review your options and decide where you want to put your retirement savings.