In general, the 401K is a great tool. Most people who invest for retirement start with their company 401K. And this is a great place to start. It’s easy, contributions are automatic, annual contribution limits are high ($16,500), and usually there is a company match (i.e. free money) to be had just for participating. But like any other retirement account, it has it’s flaws.

Lack of a Match

With the recent economic down turn, many companies ended the company matching contribution. For some people this meant a loss of income up to $16,500 annually. That stinks. So did people stop contributing? Surprisingly they haven’t. Studies have shown that this had little effect on whether people continued to contribute. But should it have? I say likely yes. Here’s why…

Limited and Expensive Funds

The vast majority of 401Ks have a limited amount of funds to invest in. This is because 401Ks are typically managed by one investment firm. For instance, if Fidelity manages your 401K, then you will get to choose from around 5-10 Fidelity mutual funds for your portion of the portfolio invested in stocks. Some Fidelity funds are great. But wouldn’t you rather have a choice of funds from Fidelity, Vanguard, Schwab, T Row Price, and other investment firms? Sure you would. The more options you have, the more likely it is that you will find a low cost fund to meet your needs. Review your company’s 401K expenses with BrightScope.com.

It May Not Be the Best Tax-Advantaged Account for You

Another reason to consider moving away from the 401K is because the Roth IRA exists. The Roth IRA and the 401K have exactly the opposite tax treatment. A Roth IRA uses after-tax dollars to fund the account, while the earnings grow tax free. When you do a qualified Roth IRA withdrawal, you don’t have to pay any taxes. This makes the Roth IRA a great product for young people, who will likely be in a higher tax bracket when they retire. Also, a Roth is also not tied to your employer, and can be opened at any mutual fund company, online stock broker, or even at a bank. Thus, your choice of funds and other investment products greatly increases just by using a Roth IRA.

To sum all of this up, if you have a company match with your 401K, at least contribute enough to get the full match. If, however, you are young, have limited choice with your 401K, and you don’t get a match, then strongly consider starting your retirement investing with a Roth IRA. Once you reach your annual maximum of $5,000, then go back and start putting money into the 401K. And who knows, maybe by then the match will return.

This post was provided by PT of ptmoney.com.

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