Of all the retirement “no-brainer” decisions facing participants, taking advantage of an employer match is probably the biggest — a guaranteed 100% or 50% return on investment. But what about participants who have maxed out their employer match, or those in a plan that doesn’t provide one? How do unmatched contributions stack up against other investment alternatives?
Financial Planning’s Donald Jay Korn takes a closer look at that question. The case for maxing out unmatched contributions include these two important factors:
• A 401(k) defers taxes on the principal invested, while other tax-efficient alternatives, like tax-managed mutual finds or ETFs, are efficient only in deferring taxes on the growth.
• By lowering a participant’s AGI, they can increase tax deductions and credits and decrease Social Security taxes.
The relative disadvantages of putting unmatched 401(k) contributions ahead of other alternatives include these:
• Returns may suffer due to limited investment options within the plan.
• Putting money in a 401(k) is easy, but getting it out it is not. Hardship withdrawals may or may not be permitted, and loans can pose tax problems, such as double taxation of interest payments.
• Post-retirement distributions can be expensive if tax rates are higher in the future.
What are the alternatives to unmatched contributions? Paying down credit card debt is one. Others include 529 accounts for parents of young children and HSAs for those who are smart enough to factor health care expenses into their retirement planning. But the best choice is probably a Roth IRA — with no RMD requirement and estate planning benefits (at least in regard to federal estate tax) that retirement plans lack. After all, “tax free” always trumps “tax deferred.” That’s a no-brainer.
