If you're committed to saving for retirement, you have to put your money somewhere. And that somewhere probably shouldn't be a savings account, CD, or even a taxable brokerage account. You don't need the IRS coming after you for capital gains every year when you're trying your hardest to build up some retirement wealth.
Generally, savers are advised to use tax-advantaged plans for retirement savings purposes because, well, they come with tax breaks. A traditional IRA or 401(k) lets you shield some of your income from the IRS by offering tax-free contributions. A Roth IRA or 401(k) gives you tax-free investment gains and withdrawals.
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If your company offers a 401(k), you may be inclined to sign up. After all, it doesn't get much easier than having your payroll department deduct contributions to your retirement plan every month so that you don't have to think about them.
But while a 401(k) might seem like a great choice for your retirement nest egg, you may be much better off with an IRA. Here's why.
You may get more investment choices
With a 401(k), you're generally limited to a bunch of different funds to invest your money in. That's not a terrible thing if you're more of a hands-off investor who would rather not research individual stocks and assemble a custom portfolio. But if you're someone who knows how to invest or is willing to learn, it's a problem.
See, IRAs allow you to hold individual stocks in your account. So unlike a 401(k), you have an opportunity to tailor your investment mix to you. With a hand-picked portfolio, you may find that your investments are able to outperform broad indexes like the S&P 500 , leading to stronger returns and a larger nest egg for you to enjoy later in life.
If you stick to a 401(k), you might also beat the broad market if you choose a mutual fund whose investment strategy does well. But even in that scenario, you're still not getting complete control over your investments. Rather, someone else -- a fund manager -- is making those decisions for you.
You may end up paying less in fees
Not getting to hold individual stocks in your 401(k) may not just cost you in terms of returns. It could also mean losing money to fees.
Popular 401(k) investments like target date funds and mutual funds are notorious for charging hefty fees, known as expense ratios -- though to be fair, your fees will generally be pretty low and reasonable with an index fund. But also, you may be looking at expensive administrative fees with a 401(k). Those are in addition to the investment-specific fees you're hit with.
With an IRA, your fees may be lower overall. And that means you get to keep more of your money.
Max out your 401(k), but look to an IRA once you do
If your employer offers a 401(k) match, it pays to sign up for its retirement plan and claim your free money in full. But beyond that, an IRA might be a better bet.
So let's say you can afford to contribute $6,000 a year toward retirement and you're eligible for a $2,000 employer 401(k) match. You should absolutely put $2,000 into your 401(k). But consider putting the remaining $4,000 into an IRA for the reasons above.
And yes, it can be a little inconvenient to have your retirement savings in two separate places. But as long as you stay organized, there's no reason not to go this route if your 401(k) charges high fees and you're not happy with its limited investment choices.
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