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Why a 401(k) Might Not Be Enough for Retirement (and What Else You Should Do)

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While 401(k)s plans are often seen as “set it and forget it” investment accounts, they’re not always guaranteed to cover all of the costs of retirement. With contribution restrictions, fees, taxes, and mandatory withdrawals, 401(k)s do have their limitations. This is why putting money into other types of investments will ensure that you meet your retirement goals.

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Why 401(k)s might not be enough

First off, 401(k)s are still a great way to save for retirement, especially if an employer is willing to match your contributions. Employer matching essentially turbo-boosts how much your savings will grow through compound interest, which can account for the bulk of your retirement savings. However, there are still some downsides to 401(k)s.

401(k) contributions are capped

If you’re under the age of 50, your maximum contribution is limited to $19,500 (or $26,000 for those 50 or older). There’s also an overall contribution limit of $58,000 in 2021, which includes contributions from your employer. While this might seem like a reasonably high limit, capped contributions make it difficult to catch up on your retirement savings for the years in which you either didn’t already have a 401(k) plan or failed to make any contributions (as is the case with many people in their twenties).

Taxes, inflation, and fees

Contributions for 401(k)s aren’t taxed until you withdraw them later in retirement, but there’s no guarantee that the tax rate will remain low when you’re ready to retire. Likewise, while stocks and long-term bonds have a long history of outperforming rates of inflation, that margin could unexpectedly shrink and cut into the expected value of your retirement fund. Plus, a lot of 401(k)s have expensive fund fees of 1-2%. As Investopedia points out, if a fund is up 7% for the year but takes an annual 2% fee, you’re left with 5%.

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Lack of liquidity, followed by mandatory withdrawals

With 401(k)s, you’re forced to follow a strict timeline that doesn’t offer much flexibility for how you can use the funds for most of your lifetime. Unless you want to pay taxes and an early withdrawal penalty of 10%, you can’t take money out of a 401(k) until you’re 59½ years of age. Then, at age 72 you’re forced to take out thousands of dollars in mandatory withdrawals, known as required minimum distributions (the amount is based on a sliding scale that increases as you age). Again, if you don’t have all the savings you need, these distributions can easily delay your retirement plans.

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Consider diversifying your investments

While a 401(k) still offers a lot of value, consider using a financial planner to help you diversify into other investments, such as real estate or other investment vehicles like a Roth IRA. Unlike 401(k)s, Roth IRAs are taxed upfront, which means you don’t have to deal with tax uncertainty and mandatory withdrawals later in retirement. By having both a Roth IRA and a 401(k), you’re protecting yourself from possible retirement fund shortfalls that can hit you later in life, when you most need the money.

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