Without a match, should you strike your 401(k)?

Kodak this week joined a growing number of companies that have of late suspended the "match" on their 401(k) plans due to weakening business. Over the years, we've encouraged workers to take advantage of the match. It's like getting a free raise, typically as much as 3 percent, or 50 cents per dollar up to 6 percent of gross pay. Considered another way, you're getting an instant 50% return on the money you're investing. And that's not counting the tax benefits, since the money is invested tax-free and you're only taxed on what's left over in your paycheck. You pay tax on what you withdraw in retirement, ostensibly at a lower tax rate than you're at now.

But with the match gone for many employees, is it still worth participating in a 401(k)? I've heard two opposing points of view:

Viewpoint 1: Don't bother. With the match gone, there's not as much incentive to keep investing in your company's retirement plan. For one, 401(k) plans typically don't offer the universe of potential investments, so they limit your options. Also, 401(k) plans--and the investments in them--can have high management fees that can eat into your investment returns. That may be especially true with plans sponsored by small and medium-sized companies. Instead, invest outside your company's retirement plan, first in a traditional IRA with the same tax benefits as a 401(k). After your salary exceeds the limit for which you're eligible for a tax-deductible contribution, move on to a Roth IRA. You'll have to invest money after tax, but then it will grow tax-free until you make withdrawals. Those withdrawals are also tax-free; what's more, there's no minimum required withdrawal with a Roth IRA. In contrast, you must begin to withdraw your traditional IRA or 401(k) assets at age 70 1/2.

"In general 401(k)s are overrated, but they’re good for certain income ranges or people who can’t take advantage of Roths," says Matt Conrad, a CPA and managing director of Complete Wealth Management in Mission Viejo, Ca. "I wouldn’t say they have no place, but in general for the average wage-earner, I would advise them to take advantage of a Roth IRA."

Viewpoint 2: Keep funding your 401(k). In fact, contribute more. If you can, make up for that missing match by replacing it with your own money. If you're getting an annual raise, use that money; you won't notice it's missing next year. Continue to put as much as you can into your 401(k), until you reach the maximum level. For one, it's easy. Simply fill out a form or two at work, and your tax-deferred investments begin. For another, it may be your best option if your income is higher than the the maximum income eligible to set up a traditional or Roth IRA. While 401(k)s may sometimes have funds with higher fees, an increasing number offer simplified, "lifestyle" or target retirement funds composed of low-cost index funds. As you age, they automatically decrease your allocation in stocks. Finally, with fewer choices you probably don't need a fee-based or commissioned professional to help you set things up.

The very fact that 401(k)s limit their investment offerings may make them better suited to the average individual investor, says Jack VanDerhei, research director of the Washington, D.C.-based Employee Benefit Research Institute. He points to a study by two Columbia University researchers showing that individual investors, faced with too many investment options, get overwhelmed. "If you give people info overload, you freeze them into inactivity. Participation drops. It’s difficult for people to know where to start," VanDerhei says.

Michael Palazzolo, a CPA and certified financial planner at Access Wealth Planning, a fee-based financial planning company in Roseland, N.J. says he sometimes recommends clients put a bit into both a 401(k) and a Roth IRA. But he leans toward the 401(k), because it's so easy for employees to set up at work.

"If you’re not going through the 401(k) you have to make sure you go out and open up those IRAs and Roths and get those contributions in," he says. "I see people procrastinating all the time."

--Tobie Stanger

Comments

[David Farrior]

I'd have to agree with the first viewpoint, that the Roth IRA is a better choice. However, there are limits on the Roth ($5,000 for tax year 2008), and after meeting that limit, I feel as though I still need to save more towards retirement. I am lucky enough to have a 401k with favorable fund choices and low management fees. In summary, why not max out the Roth first, and then contribute anything else you can muster into an unmatched 401k?

[Angelo]

I tell you what I am not a 401k guy. I like to save my money myself, and buy real estate, but if their is a time to keep investing in your 401k and add more to it, then this is it.

My reason is simple stocks/funds are cheap. Up until this year I have only being contributing 2% but increased that to 5% in the past few months.

It may take a while for things to get better with the economy but in the meantime you can make some nice contribution before the market rallies.

Angelo
http://www.zoocaro.com

[KC]

I fall into the no match, no contribute camp. The only attractiveness to a 401k is the employer match - that's free money. Otherwise the expensive junk that is offered in most 401ks is just not worth the effort. I'd rather max out my Roth or regular IRA (if not eligible for a Roth) because I have a wide selection of investing choices, mainly low cost index fund and individual stocks. If I max out my Roth and then have some money left over I might consider my 401k for the tax advantages, but be wary of the fees for the funds offered - they'll eat profit over time.

[William]

A timely post.

Some other points to watch for:

1. If you're saving a lot of money, have maxed out your IRA, and already have a sufficient emergency fund, a 401k is a good place to save money.

2. A 401k plan with a large company often has mutual funds that have MUCH better expense ratios than you can get on your own. My company offers Vanguard "Signal" shares for their S&P500 index; the normal shares (VFINX) have an expense ratio of 0.15%, while Signal shares (VIFSX) have 0.07% expense ratio. Nice!

-Wm

[Steve]

According to me back of the envelope calculations, a 401k has to be relatively bad to not be worth contributing to. Using these numbers
* Current tax bracket 25%
* Future tax bracket 25%
* Future capital gains rate 15%
* Earnings 10%/year
* Years 30
You can handle about 0.5% extra costs in your 401k. Maybe you think the future tax rates I have here are optimistic, or maybe you think they’re pessimistic.

But that has one really unfavorable assumption: that you’ll stay with your current employer until retirement. If you assume you’ll move one about once every five years, then you can handle up to 3% extra costs! Not quite enough to handle the 4% loads you might have found back before the internet brought investing to the masses, but I have yet to see a 401(k) that had costs that high.

I agree that you should first contribute to a Roth IRA fee of any of these fees or constraints; however, there are (or ideally should be) a lot of people who are saving more than $5,000 per year for their retirement.

[Bruce]

This is a real "weak-sister" article. I was attracted to it for some real advice in a difficult decision area, but the gist of this article is, basically, "Yes, and No". Where are the journalists today, now that the newspapers are going away?