3 Unexpected Drawbacks of 401(k) Plans

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It's not a given that you'll have access to a retirement plan through your job. While many large companies offer a 401(k) plan, if you work for a small business, there may not be enough employees to make a 401(k) cost-effective. In that case, your best bet is probably to save for retirement using an individual retirement account (IRA) .

But even if you have a 401(k) plan available to you, an IRA might be a better move. That's because 401(k)s can come with some pretty surprising drawbacks. Here are three you should know about.

1. You're not guaranteed to get an employer match

Vanguard, a major 401(k) plan provider, says that in 2023, 50% of its plans provided an employer match. Meanwhile 36% of its plans offered both employer matching and non-matching contributions, and 10% offered non-matching contributions only (meaning, free money even for those who don't contribute to their retirement accounts out of their earnings).

But while these are some pretty large percentages, they also tell us that not every company offers a 401(k) match. And you may, unfortunately, be one of the employees who isn't entitled to one.

It generally pays to contribute to a 401(k) up to the limit your company will match. If you don't, you're giving up free money. But if there's no match in your 401(k) at all, then you may want to consider saving in an IRA instead.

2. You may have to wait a long time to get your match -- and risk losing it

Years back, it was common to get a job out of college and stay with the same company for years, or even decades. But job-hopping is a lot more common these days. And moving from one company to another can often mean snagging a nice boost in pay and furthering your career.

Here's how that ties into 401(k)s: While many employers offer a 401(k) match, a lot of companies also impose a vesting schedule for actually getting your match. Under one of these setups, you have to remain an employee for a period until your employer match is actually yours to keep.

Now, 401(k) vesting can take on different forms. Your company may, for example, have a three-year vesting period where for every year you remain employed, you officially take ownership of 33.3% of your match.

But some companies have an all-or-nothing vesting schedule where, for example, if you don't remain employed for three years, you get none of your match -- even if you leave your job 10 days before your three-year anniversary.

Some vesting schedules are so restrictive that they make it difficult to claim even a portion of a 401(k) match. It's important to read your employer's policy. And if it seems unlikely that you'll get to keep your company match, then you may want to ditch its 401(k) and use an IRA instead.

3. You may not have great investment choices

IRAs are known to offer way more investment choices than 401(k)s. With a 401(k), you generally cannot buy individual stocks. Rather, you have to invest in different funds.

For some people, that may not be a problem. If you're more of a hands-off investor, a target date fund or index fund, both of which are popular 401(k) choices, might work just fine for you. But if you'd rather get a say in how your retirement portfolio is invested, then a 401(k) may not work.

Also, the investments you choose within your 401(k) will dictate what fees you pay. And certain types of funds are notorious for charging higher fees.

Index funds, which simply aim to match the performance of existing market indexes like the S&P 500, generally offer the benefit of low fees. But if you choose a target date fund, which is a fund that adjusts your portfolio's risk profile based on how close to or far from retirement you are, then you can expect to lose a lot more money to fees.

There can also be costly administrative fees in a 401(k) on top of the investment fees you're charged. So all told, an IRA can be less expensive from a fee perspective on top of giving you more investment options.

If you're happy with your company's 401(k) plan, then there's no need to abandon it in favor of an IRA. But if any of these 401(k) pitfalls apply to you, it's a sign you may want to pass on your workplace plan and choose an IRA for your retirement savings instead.

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