8 Flat-Out Lies You’ve Been Told About Your 401(k)

Millions of workers keep the majority of their nest egg in a 401(k) retirement account. Thanks to tax incentives, employer matches and other perks, it’s hard to ignore this popular investment vehicle as you prepare for retirement.

However, it’s easy to become confused about the specifics and assume things about 401(k) plans which might not be true. Here are some lies you have been told about your 401(k).

A 401(k) plan is often the best place for workers to start investing so they can save for retirement. But this isn't always the case.

Some 401(k) plans offer a limited number of investment choices. Other plans have high fees. In addition, you typically are unable to use a 401(k) to invest in individual stocks or bonds.

Also, some 401(k) plans don't offer a Roth option. This can be a deal-breaker for workers who would prefer to pay taxes today in exchange for never having to pay them in the future.

In short, your 401(k) may have limitations that prevent you from investing money according to your personal goals and desires. If this is true for you, you might want to put some retirement savings in another type of account.

When you're looking to borrow money, 401(k) loans seem like a good option. You can borrow from the retirement account relatively easily. And instead of paying interest to a lender, you pay the interest to yourself.

However, there are some drawbacks to consider before taking a loan from your 401(k). If you part ways with your employer and still have an outstanding loan, you may be required to pay back the sum quickly, with the actual time frame depending on the plan. 

Fail to pay back the money promptly, and the amount may be considered an early distribution subject to a 10% early withdrawal penalty and income taxes

Taking a loan from your 401(k) also robs that money of the power of compounding until you pay back the cash.

Many 401(k) plans come with a range of fees, including investment fees, plan administration fees, and individual service fees.

These fees are usually small, but they can have a huge impact on the size of your nest egg. In fact, over decades, you could potentially lose tens of thousands or even hundreds of thousands of dollars to fees.

The U.S. Department of Labor says an employee with a 401(k) balance of $25,000 who earns a 7% return on investments over the following 35 years will have a nest egg of $227,000 at retirement if fees and expenses are 0.5%.

However, if fees and expenses are 1.5%, the balance dwindles to just $163,000.

The IRS typically penalizes you heavily for taking funds from your 401(k) before you turn 59 1/2. There is a 10% early withdrawal penalty, plus you are required to pay income tax on the withdrawal.

However, there are some instances when you can take out the funds penalty-free. There are nearly two dozen exceptions that exclude you from the penalty, including:

• Birth or adoption expenses
• Medical expenses
• Health insurance while unemployed
• Natural disaster expenses
• Higher education expenses
• Personal emergencies

In the past, the IRS required folks who turned 72 to begin taking required minimum distributions (RMDs). However, the rule has recently changed.

Now, you must take the first RMD after you turn 73. For example, if you turn 73 in 2024, you must take your first RMD no later than April 1, 2025.

The age you must begin taking RMDs is scheduled to jump to 75 in 2033.

The majority of 401(k) accounts are tied to employers. In the event that the company shuts down, goes into bankruptcy, or is acquired, the cash in your 401(k) could be tied up for months or even a year or more while the legal side is sorted out.

Given that there is a chance that your money could be frozen during such a period, it often makes sense to keep at least some savings outside a 401(k) plan.

Unlike with IRAs, there is no income limit that prohibits high earners from contributing to a 401(k) plan.

However, there are situations where high earners and others might run into caps on how much they can contribute. So, always check with your plan administrator to see if such limits apply to you.

When you change employers, you don’t always have to move the money into your 401(k) account.

For example, as of 2024, you can typically leave your account with your old employer if you have more than $7,000 in it. That means you can keep the money invested where it is, hoping it will continue to grow and let you build wealth while you sleep.

A 401(k) plan can be a great place to grow your wealth and boost your odds of a secure retirement. But you shouldn’t necessarily believe everything you hear about these accounts.

If you have questions about 401(k) plans, consider asking your human resources department at work for clarification. Or, consult with a financial advisor who can offer guidance.