Disadvantages of a 401(k) compared to a brokerage account?

[shelbster]

Obviously there are a lot of threads similar to this one but I haven't found any that ask this exact question.

I got some advice from a financial planner several years ago and am not sure how much it's BS.
(Context: I got a crash course in the differences between fee-only financial planners and ones who work on commission when I was almost convinced to sign up for full life insurance. She also recommended actively managed index funds. No, thank you, on both accounts.)

Her advice was that in terms of prioritizing which accounts you put your money in, you should absolutely contribute to your 401k up to the employer match. So far, so good. Free money is good.

But, she said, her colleagues typically didn't recommend maxing out your 401(k) because those accounts are relatively inflexible -- i.e., they have a limited selection of investment funds, and the terms (and fees) associated with them can change without you being able to do anything about it.

Does this seem legit to you or does it sound like a financial planner trying to get her clients to put money into a brokerage account where she can get commission off of it?
If it is BS, do you see any truth in it?



Personally, I've been hitting my employer match then maxing out IRAs then investing in non-tax-advantaged brokerage accounts.
And I think that having some money in brokerage accounts is a good idea, since I'm hoping to FIRE long before I can withdraw money from retirement accounts without penalties.
But I'm thinking more about this and thinking that it's stupid not to sink money into that 401(k) and reap the associated tax advantages. Especially because I might hit a point this year where I make too much money for the IRAs to do much good, tax wise.

[jeff191]

Mostly BS based on some truths. I've been on both sides during my career - was an investment advisor (not insurance) for a number of years and then ended up on the other side managing a team + vendors that handled retirement plan administration for one of the biggest companies in US.

 - 401(k)s will typically have less investment options than IRAs since every fund that goes into a plan has to be approved by the plan sponsor. For smaller plans, most just use whatever menu of funds that the plan provider offers. For larger plans, the choices often go through a committee for approval. These days, there is a lot more focus on investment options as there were so many lawsuits. We'd often get requests to add new funds like emerging markets to the plan and the answer was always no because it wouldn't pass the investment committee (too much risk that it would tank at some point and we'd get involved in lawsuits over appropriateness). We also benchmarked against other plans of our size to ensure that fees were low and we'd often negotiate with vendors to lower costs - all of this was documented in case participants questioned the fees. This stuff isn't done at smaller plans as it's not really feasible if there are only 50 participants in a small plan but the general rules and regs are the same.

- The terms and fees can change but this is a highly regulated world and plan participants have to be notified of any changes either through fee disclosures or summary of material modification notices. Typically the changes are due to regulatory changes and such. The fees don't usually change much unless the plan is changing investment options.  It's true that you can't opt out of the changes but they've been run by legal and compliance either by the plan sponsor or provider before happening. Compare this to an investment advisor who can change their fees at pretty much any time.

- Most advisors will say the same thing about 401(k)s for the simple reason that they can't get paid on the money in those accounts. There are great 401(k)s and there are terrible ones. Same can be said for IRA and brokerage account providers. But you just have to look at what options are available to you.

[bacchi]

Investment order: https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153

It'd be pretty difficult for an employer's 401k to have so many fees to make the tax-deferred savings not worth it.

It's best to have 5 years of Roth contributions + taxable investments when you ER. Even considering the early withdrawal penalty, though, the 401k is hard to beat for those people who retire to a lower tax bracket.

[Watchmaker]

*Some* 401ks have such bad options that it doesn't make sense to invest past the company match, but most do not. I think the rule of thumb is if the fees are less than 2%, it's still worthwhile to max it out.

Remember, you probably won't be with this employer your whole career, so you will have options later to roll the money out of this 401k into a different plan.

[naj89]

You will want to look at the plan documents of your 401(k). Depending on your FIRE timeline, you may be able to begin taking withdrawals prior to 59 1/2 from your 401(k). You may also be able to roll money over to an IRA while still employed if you want to diversify your fund options.

Shameless plug also for considering your HSA if you qualify through an HDHP. This are often overlooked and can be very tax-adventageous at low cost if you use, for example, Fidelity, for your custodian.

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[BrightFIRE]

But, she said, her colleagues typically didn't recommend maxing out your 401(k) because those accounts are relatively inflexible -- i.e., they have a limited selection of investment funds, and the terms (and fees) associated with them can change without you being able to do anything about it.

Does this seem legit to you or does it sound like a financial planner trying to get her clients to put money into a brokerage account where she can get commission off of it?
If it is BS, do you see any truth in it?

Personally, I've been hitting my employer match then maxing out IRAs then investing in non-tax-advantaged brokerage accounts.
And I think that having some money in brokerage accounts is a good idea, since I'm hoping to FIRE long before I can withdraw money from retirement accounts without penalties.
But I'm thinking more about this and thinking that it's stupid not to sink money into that 401(k) and reap the associated tax advantages. Especially because I might hit a point this year where I make too much money for the IRAs to do much good, tax wise.

Short version: Yes, she was trying to get your money.

Long version: Do the math! You aren't the first to think of this. You need to read the Mad Fientist: https://www.madfientist.com/how-to-access-retirement-funds-early/ and JL Collins' stock series: https://jlcollinsnh.com/2013/06/28/stocks-part-viii-b-should-you-avoid-your-companys-401k/ <--Read all the way to the addenda.

I will also note that the 1st year I maxed out my 403b (same thing, but for nonprofits), I saved so much in taxes that I gave myself the equivalent of a 8% raise. We have Vanguard options, so low fees anyway, but even if the plan had higher fees, it would have been worth it for the taxes saved. In fact, you might still be able to contribute to a TIRA if you reduce your income via 401k contributions.

[shelbster]

Good stuff here, thanks everybody! I will definitely have to read those links.

My current company’s 401(k) is through Vanguard and I have never been unhappy with the choices.
Also, having some money in an easily accessible brokerage account does make sense, but I bet I mostly don’t need it and can get through until age 59 1/2. Especially because you can withdraw money from some retirement accounts for the purchase of your first house, which I suspect will be a major expense in my life between now and when I reach a “normal” retirement age.
But that’s just my situation!

Great call out about the HSA, also!
I don’t have one of those available to me right now, but gosh it would be useful one day.
An FSA wouldn’t hurt either, but that’s just me wanting to gripe rather than a real contribution to the topic at hand.

[Proud Foot]

Her advice was that in terms of prioritizing which accounts you put your money in, you should absolutely contribute to your 401k up to the employer match. So far, so good. Free money is good.

Good so far

But, she said, her colleagues typically didn't recommend maxing out your 401(k) because those accounts are relatively inflexible -- i.e., they have a limited selection of investment funds, and the terms (and fees) associated with them can change without you being able to do anything about it.

This is highly variable depending upon your work plan and personal situation. What she said is typically true about having limited selection of funds and terms and fees changing without your input. The biggest thing with this though is the fact that most people do not stay at a single employer long term. The savings on income taxes during that time frame will more than make up for the higher expenses and limited options if you are rolling over your account to an IRA and investing in funds with low expenses each time you change jobs.

Does this seem legit to you or does it sound like a financial planner trying to get her clients to put money into a brokerage account where she can get commission off of it?
If it is BS, do you see any truth in it?

She is definitely trying to get her clients to invest more outside of a 401k and invest it with her.

Personally, I've been hitting my employer match then maxing out IRAs then investing in non-tax-advantaged brokerage accounts.
And I think that having some money in brokerage accounts is a good idea, since I'm hoping to FIRE long before I can withdraw money from retirement accounts without penalties.
But I'm thinking more about this and thinking that it's stupid not to sink money into that 401(k) and reap the associated tax advantages. Especially because I might hit a point this year where I make too much money for the IRAs to do much good, tax wise.

Max out that 401k while you can! Especially since your plan is through Vanguard. There are many ways you can access that money before 59.5 without having penalties.

[shelbster]

Max out that 401k while you can! Especially since your plan is through Vanguard. There are many ways you can access that money before 59.5 without having penalties.

I spent a couple days looking at my finances (long overdue) and this is what I'm doing now. Thanks!

[Watchmaker]

Also, having some money in an easily accessible brokerage account does make sense, but I bet I mostly don’t need it and can get through until age 59 1/2. Especially because you can withdraw money from some retirement accounts for the purchase of your first house, which I suspect will be a major expense in my life between now and when I reach a “normal” retirement age.
But that’s just my situation!

Getting money out of a 401k earlier isn't hard with some planning, particularly if you retire early (lookup Roth conversion ladder).

[FIREstache]

I can pull more money from my brokerage than I can from my 401K before hitting the threshold taht decreases my ACA PCT and CSR subsidies.  I have a combination of different accounts that allows me to make sufficient withdrawals while staying in a low income range that will provide decent ACA PCT and CSR.