What should I do with my funds if I am unsatisfied with a 401(k)?
I began putting money into a 401(k) this year. I only have about $1,000 dollars in the account. I have been doing more and more research and have decided that a 401(k) is neither a safe nor smart investment vehicle. About how much should I expect to lose if I cancel and withdraw my funds? Would an advisor suggest I do something else, such as transfer the funds somewhere to avoid a severe penalty?
First, let's be clear that a 401(k) is not an investment, it is simply a type of account. Whether or not it is "safe" or "smart" has more to do with the choices you make in the plan, and less to do with the fact that it is a 401(k). This "research" you have been doing doesn't sound very credible.
If you are still working for the same employer, ask if there are any advisors who service the plan and provide employee education. Talk with someone who understands the specifics of the plan, and then you can make a better decision about whether or not to keep investing.
If you are no longer with your employer, you can withdraw the money. However, you will pay income taxes and a 10% penalty if you are younger than 59 1/2.
You can transfer the money to an IRA account, however, it may be hard to do that without paying a sales charge on the new investment.
Hope that helps.
All the best,
Wyatt A. Moerdyk, AIF®
As you began to do more research, you will learn that a 401(k) is only a tax-sheltered vehicle that allows you to save in a tax-efficient manner. By itself, 401(k) is only a tax code. It’s the investment menu that is offered by your company that may not be prudent. Thus, the question becomes what to do next.
You could ask your company for a change of the investments. This could be the most opportune time. Because of the recent lawsuits from employees, the Department of Labor has recently warned the companies to provide a more judicious and low-cost investment menu. Consequently, more and more companies begun to comply, and this also drove up the competitions from the 401(k) investment providers. They lowered their price that no one had ever predicted.
If the company is reluctant to change and you really do not like to continue to make the contribution to your 401(k), you really have to have the financial discipline on your own to save. Here’s the comparison. If you have the capability, you could save $30,250 on a pre-tax basis ($18K for 401(k), $5,500 on a traditional IRA, and $6,750 for an HSA). At 25% tax bracket, you could save $7,562 tax. Now, without the 401(k), the maximum contribution to the IRA and HSA is $12,250, which saves you $3,062.5 tax. You could save that $18K in a taxable account, but you end up paying a 15% long-term capital gain tax each and every year. Unless you use an annuity account, which spares you the annual capital gain tax, the underlying fees from an insurance company and so-so investment menu could mean you’re no better than leaving the 401(k).
Depending on your age and the company’s 401(k) plan language, you may or may not be able to withdraw the 401(k) money without risking being penalized by the IRS. So, do some due diligence, and best!
A 401(k) plan (in and of itself) is not an investment. The 401(k) plan is a retirement account and there are many benefits associated with the 401(k), such as income tax deferrals, pre-tax contributions (if not a Roth contributions), employer matching contributions (within plans that offer that benefit), and a variety of investment options. The last benefit, in conjunction with your contributions, is how the account value increases.
You mentioned that 401(k)s are not safe. I'm not sure how you are defining safety. Do you mean safe from creditors or safety of principal? Or safe something else? If safety pertains to creditor protection, then there is nothing to worry about there. However, if safety pertains to protection of your principal, that will be determined by the selection of investments within the account.
As far as being able to "cancel" and "withdraw the funds," you should be able to stop contributions into the plan. However, typically, you are unable to withdraw the funds without tax consequences unless the plan offers in-service rollovers within the plan. Even with the in-service rollover, you may not be able to rollover the entire account balance and you also must have attained a certain age.
It would probably be a good idea to reevaluate your decision to leave the 401(k) and give the plan more time. You mentioned just starting the plan this year. That is not a sufficient amount of time to give a proper assessment of the plan.
I absolutely agree with the other responses, so the only thing I will add is that if you plan to stay with this employer for a while, don't overlook the company match if one is provided. If your employer matches and you qualify to receive those proceeds, then that is free money that you don't want to leave on the table. As long as you are contributing, they will contribute. So, review the investment options available within the plan and take advantage of the company match, if that's a provided benefit. I hope that helps you.
You may not move the funds out of the 401(k) until you leave the firm. However, most 401(k) plans have multiple choices into which you may invest. You should be able to find one or more that satisfy your needs. You might want to use a CFP® to assist you in finding the right funds to use.