Photo credit: jb
Okay, the title might be a little misleading in regards to how I really feel about 401(k) plans… I do think that these plans are (or can be) good for a lot of folks, as long as they use them correctly and follow sound investing principles. But that’s not what this post is all about.
The 401(k) plan is one of the places that the average Joe Employee is not well-served – in ways you don’t realize.
The 401(k) Dirty Little Secrets
Without getting too technical about all this, one problem is that most 401(k) providers are able to get away with supplying a plan that is high in cost when compared to the rest of the marketplace, with no one but the plan participants (read that “employees”) bearing the brunt of the cost. And furthermore, the plan participants have little to no say in making changes to the plan in their favor.
It doesn’t have to be as nefarious as the employer choosing to stick the employees with high fees – it likely is a given fact that costs are higher for smaller employers’ retirement plans because they can’t achieve an economy of scale to keep costs low.
At any rate, most individuals can do much better (cost-wise) than 401(k) plans by looking to the low-cost alternative investing options, such as no load mutual fund companies and low-cost brokerages.
Since there is no legislation to make true fiduciary responsibility a requirement – meaning that the plan provider must act in the best interests of the plan participants – most often the plan and the investment choices are among the highest internal cost investing options available. And because the fees are charged totally at the back end (at the mutual fund company, usually) and the employer sees little or no up-front costs, the employer is happy with the plan.
In addition, the mutual fund company is thrilled to have a captive audience with only their funds available to be invested in – which translates into new deposits for the company for nearly zero marketing cost. Of course the agent who sold the plan is ecstatic: for virtually no ongoing effort, he is able to rake in a percentage from each and every dollar that goes into the plan.
On top of the higher costs and limited choices, 401(k) plans are the most restrictive of all contribution-oriented retirement savings options available. Typically, the only way you can touch the money in the plan is to leave employment at the company. 401(k) plans, as a concession, do allow loans against a portion of the holdings, which is unheard of for IRA plans.
Sterling Raskie, MSFS, CFP®, ChFC®
The latest in our Owner’s Manual series, A 401(k) Owner’s Manual, was published in January 2020 and is available on 
A Medicare Owner’s Manual, is updated with 2020 facts and figures. This manual is available on 
Social Security for the Suddenly Single can be found on Amazon at 
Sterling’s first book, Lose Weight Save Money, can be 
An IRA Owner’s Manual, 2nd Edition is available for purchase on Amazon. Click the link to choose the 
Jim’s book – A Social Security Owner’s Manual, is now available on Amazon. Click this link for the 
And if you’ve come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed “advisor’s advisor”.
Informative read! I believe that the 401K plan is an extremely beneficial retirement plan for employees. It does, however, have some limitations, such as restrictions on fund withdrawal and limited investment options.
No offense, but I just don’t understand the hate for the 401(k).
The ability to take up to $19,500 of salary off your taxable income and shift that burden to decades later is amazingly powerful. The ERISA protection on the 401(k) is also amazing. Nothing else compares to this.
I’ve had a number of retirement plans with employers ranging from four to 80,000 employees. All of them gave me access to the popular Vanguard funds, at worst Admiral class, at best Institutional (i.e. something you usually can’t get outside an employer retirement plan). Some of them had weird ticker symbols that made me suspicious, but after careful monitoring, they’ve performed identically to the Vanguard fund they corresponded to. No hidden fees or complications.
Book keeping type fees have varied from non-existent to incredibly annoying but never to the point that it outweighed the benefits of tax deferral. The key is having perspective on how long you expect to be at an employer and rolling these funds into an IRA or the next 401(k) as these fees only get really insidious over long spans of years.
I started saving with my first 401(k) years ago in order to get the employer’s generous match and avoided saving beyond that because of all these horror stories about “hidden fees” and “dirty little secrets”. I spent years trying to find these and never did because they didn’t exist. I feel foolish for ever trusting such poor advice and it angers me that such advice is still being given.
If someone has a horrible 401(k) that has high management fees and horrible funds with high expense ratios and poor matching, etc., then, yeah, that’s a horrible plan that they might want to avoid it if the tax benefits do not outweigh this, but it is also easy to get roped into high expense ratio active mutual funds, personal advisor fees, etc. with IRAs and brokerage accounts as well if you aren’t careful.
No offense taken. I think my point was lost, however – I’m not against the 401(k), certainly not a hater. This post is purely to point out some of the downsides to the 401(k) that folks don’t usually think about. I think in the long run a 401(k) does far more good than harm (if any harm at all!) and when one is available you should take advantage of it. But you should do so with your eyes wide open.
Thanks for your insights!
The 401k allows a larger employee contribution vs the IRA. The 401k may may include an employer match that also grows tax deferred.
Great points, Clyde – wasn’t saying to throw the baby out with the bathwater. There are redeeming benefits to 401(k)s, for sure.
Also, ask for a ticker to check out the 401 fund on Morningstar and you find out it doesn’t have one. Ask the 401k manager for some detailed info and they’ll typically say it’s a prprietary fund, that info’s not available.
Right! Lack of transparency into funds is a big problem with 401(k)s, for sure.