Updated on 08.18.16

What to Do If Your 401(k) Stinks

Your 401(k) is often the easiest place to start investing because the account is already set up for you and your contributions can automatically be deducted from your paycheck.

Unfortunately, many 401(k)s are still behind the times in terms of offering high-quality, low-cost investment options that maximize your odds of success.

So, how do you know if your 401(k) is good or bad? And if it’s bad, what should you do? Here’s a quick guide that will help you figure it out.

What Makes a 401(k) Bad?

How do you know if you have a bad 401(k)? Here are three big things to look for.

1. No Employer Match

Many employers offer a matching contribution, meaning that every time you contribute to your 401(k), your employer contributes as well — up to a certain limit.

This is a fantastic benefit and it’s the main reason that most people should prioritize their 401(k) over other retirement accounts, at least at first. If your employer matches your contributions dollar per dollar (or even half that), you won’t find a better return on investment anywhere else.

If you don’t have an employer match, that doesn’t necessarily mean that you should avoid your 401(k). But it does remove the big advantage that the 401(k) has over other retirement accounts, which means that it’s time to start looking at other options.

2. High Fees

Cost is the single best predictor of future investment returns. The less an investment costs, the more likely it is to produce higher returns.

Unfortunately, many 401(k)s are littered with fees that slowly but surely eat away at your retirement savings. There are a number of different types of fees to watch out for, from the cost of your investments to various administrative fees.

If your 401(k) charges excessive fees, you should think twice before contributing your hard-earned savings.

3. Limited Investment Options

By definition, 401(k)s have limited investment options. Your employer, along with the plan sponsor, chooses a set of investments to include in the plan and that’s all you have to work with.

Now, that’s not necessarily a problem. It’s certainly possible to choose a small set of fantastic investments, and many plans do just that.

But in some cases your 401(k) may not have the specific investments you want. And if that’s the case, you may want to balance your 401(k) with other accounts in order to implement your desired investment strategy.

With that said, if you get a match and the fees are reasonable, you can almost always find at least one good fund. So I wouldn’t ignore your 401(k) simply because you can’t invest exactly the way you want.

What to Do With a Bad 401(k)

If your 401(k) falls into one or more of the categories above, what should you do? Should you ignore your 401(k) completely? And if so, where should you save instead?

Here’s how I would approach it.

1. Take the Match

If your employer offers a matching 401(k) contribution, it’s worth taking, even if you’re charged excessive fees. You just aren’t going to beat an immediate 50% to 100% return on investment, which is what a match typically represents.

2. Prioritize Other Tax-Advantaged Accounts

Once you’ve maxed out the match, or if your employer doesn’t offer a match, then you’ll likely be better off prioritizing other retirement accounts so that you can minimize your fees and have greater control over your investment choices.

In all likelihood this means starting with either a traditional or Roth IRA. These are tax-advantaged retirement accounts that you open on your own and that allow you to contribute up to $5,500 per year (though there are some restrictions at higher incomes). Popular, low-cost IRA providers include Vanguard, Betterment, and others you can find here.

If you’re eligible, another great option is a health savings account. These accounts offer special tax benefits when used for medical expenses, but in the right situations they can also be a powerful retirement account. You can get help finding a health savings account here.

And don’t forget to check your spouse’s options as well if you’re married. If he or she has a good 401(k), you could simply decide to contribute more money there.

Finally, if you have any self-employment income, even if it’s on the side of your day job, you can look into the self-employed retirement accounts available to you. Like with IRAs, you have a lot of control over the fees and investment options, and some of these accounts allow you to contribute up to $54,000 per year. Talk about turbocharging your retirement savings!

3. Pay Down Debt

Depending on your situation, this could actually be Step #2.

If you look at the interest rate on your debts as a guaranteed return on investment, prioritizing extra debt payments over retirement savings can make a lot of sense, particularly if your alternative is a bad 401(k).

Let’s say you have student loans with a 6.8% interest rate. If you pay it off, you’ll essentially earn a 6.8% return on that money (because you won’t have to pay all that interest). That’s in line with what many experts are forecasting for long-term stock market returns, and paying it off comes without any risk that you won’t actually get that return. Every extra dollar you put towards that debt automatically saves you 6.8% in interest.

And even at lower interest rates it can make sense to prioritize paying off debt over contributing to a bad 401(k). Because even if the numbers are close, the emotional satisfaction of getting to debt-free is tough to beat.

4. Consider a Taxable Investment Account

The question of whether it’s better to use a taxable investment account than a 401(k) is a complicated one that depends heavily on the specifics of your situation. But here are a few things to consider:

  • Your 401(k) would have to be excessively expensive for the fees to outweigh the tax benefits over a taxable investment account.
  • The longer you plan to stay with your current company, the more of an impact those fees will have. Meaning a taxable investment account would start to be more appealing.
  • The tax deduction and tax-free growth within a 401(k) will be more advantageous in higher tax brackets.

5. Use Other Accounts to Balance out Your Investment Strategy

Hopefully you can find at least one good fund within your 401(k). For example, many 401(k)s offer an S&P 500 index fund with minimal fees, even if the other funds are expensive.

If that’s the case, take advantage of those one or two good funds in your 401(k), and use your other retirement accounts to fill out the rest of your investment strategy. It’s okay for any single account to be out of balance as long as the sum across all accounts falls in line with your target plan.

Don’t Let a Bad 401(k) Hold You Back

A bad 401(k) isn’t ideal, but it isn’t a death sentence either. You can still save and invest well for retirement as long as you know where to look.

Remember that the real key to investment success is saving enough money, no matter where you’re putting it. Focus on that first, do the best you can with the rest, and you’ll be just fine.

Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.

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