The 401K program offered by my employer doesn't include a company match.

Should I participate in the plan? What are the criteria one should use for estimating the worth of the situation?

  • 5
    A 401k plan allows you to save more money for your retirement than you can in an IRA. Whether this is important in your life plan is something that you need to figure out. Some people feel that they cannot afford to put money away: the salary is too low, or they need the money for other things such as diapers for the baby or the latest gizmo or alimony payments etc. Some conscientiously cut back on current expenses as much as possible to put money away for the future. The company match, if any, is icing on the cake, but if you eat your cake, you don't get the icing; you have to save your cake. Jul 14 '12 at 23:30
  • @DilipSarwate that should've been an answer...
    – littleadv
    Jul 15 '12 at 2:33
  • Are you saying "Let them eat cake" or "You can't have your cake and eat it, too"? Jul 15 '12 at 3:15
  • I asked a similar question, maybe those answers will be relevant to your situation as well!
    – bhamby
    Jul 17 '12 at 18:11

With a match, the 401(k) becomes the priority, up to that match, often ahead of other high interest debt.

Without the match, the analysis is more about the cost within the 401(k).

The 401(k) is a tax deferred account (let's not go on a tangent to Roth 401(k)) so ideally, you'd be skimming off money at 25% and saving it till you retire, so some of it is taxed at 0, 10, 15%. If the fees in the 401(k) are say 1.5% between the underlying funds and management fee, it doesn't take long to wipe out the potential 10 or 15% you are trying to gain.

Yes, there's a risk that cap gain rates go away, but with today's tax law, the long term rate is 15%. So that money put into a long term low cost ETF will have reinvested dividends taxed at 15% and upon sale, a 15% rate on the gains. There are great index ETFs with sub - .1% annual cost.

My simple answer is - If the total cost in that 401(k) is .5% or higher, I'd pass. Save the money in an outside account, using IRAs as best you can.

(The exact situation needs to be looked at very carefully. In personal finance, there's a lot of 'grey'. For example, a frequent job changer can view the 401(k) as a way of saving pretax, knowing the fee will only last 2 years, and will end with a transfer to the IRA)

  • This is a really good answer that gets to the meat of the how you can start to estimate the worth of a 401(k) program tax savings vs the extra fees you would pay. However, an important point not stressed is not only is the original amount tax deferred but all dividends, interest and realized gains are tax deferred as well. This is very important for someone with many years to retirement. This makes the "break-even" fee amount much higher than 0.5% for most people. Likely higher than 1.5%. Especially, as people tend to change jobs fairly frequently in this day and age.
    – rhaskett
    Jan 13 '15 at 20:32
  • Also, if your income is too high you get a lower or no tax deduction from IRA contributions, but you do with the 401K as the contributions are pre-tax. Jan 13 '15 at 21:31
  • @rhaskett - I did concede that the frequent job changer is far less impacted by the fee level, but it's a given the 401(k) defers tax on all growth regardless of source. Jan 14 '15 at 16:36
  • For instance, for a person in the 28% tax bracket (15% cap gains), a pre-tax growth rate of 6% and the 0.5% mutual fund fees you note on their 401(k) vs 0.10% etf fees. A person would have to work well over 20 years at the same place before the 401(k) start to be a relative bad deal. That is changing your job once in your life.
    – rhaskett
    Jan 14 '15 at 20:53
  • At a more punitive 1% mutual fund fees the "break-even" point is working at the same job for 12 years, but my calculation assumes you are 70 at that point. If you are younger than 70-12=58 than the 401(k) is still a better deal. The take away here is that unless you are middle aged, your 401(k) fees are awful, won't ever improve and you will be staying at a job for over a decade tax deferral is the better option.
    – rhaskett
    Jan 14 '15 at 21:04

Another consideration that is not in the hard numbers.

Many people, myself included, find it hard to have the discipline to save for something that is so far off. The 401K plan at work has the benefit of pulling the money out before you see it, so you learn to live on what is left more easily. Also, depending on the type of 401K it attaches penalties to using the money early disincentive you to pull it out for minor emergencies.


I believe @Dilip addressed your question alread, I am going to focus on your second question:

What are the criteria one should use for estimating the worth of the situation?

The criteria are:

  • Are you between two tax braket? If yes, you might want to take advantage of the $17,000 dollars max 401K contribution to get your Adjusted Gross Income below the tax bracket.
  • Do you have enough cushion that you can afford to save more than what a traditional IRA allows? Traditional IRA lets you take advantage up to $5,000 with tax benefits, the 401K to the 17K limit discussed earlier.
  • Some Employers 401K providers will allow for cheaper investment products. Without transaction fees, or other.

I hope this helps.

  • 2
    What does tax bracket have to do with it? How is reducing the AGI from one tax bracket to another any different than reducing it within the same bracket?
    – user102008
    Jul 15 '12 at 7:42
  • There is no real advantage of changing tax brackets as the tax bracket change only affects the marginal (last bit) of money, but it is generally good to lower your taxable income no matter which tax bracket you are in.
    – rhaskett
    Jan 13 '15 at 20:24
  • 2
    @rhaskett Not true. Thanks to recent tax changes in the US, tax brackets now have "knock-down" (or, in this case, "knock-up") effects. For example, someone who lands in the highest marginal income tax bracket by even $1 of income now has to pay 20% on all her long-term capital gains versus 15% if she had earned just $1 less in ordinary income.
    – dg99
    Jan 13 '15 at 22:25
  • @dg99 Wow, you are right. That is a poor design. Your comment is only really applicable to people right on the border of the highest tax bracket but it could be a big deal in that case. Still lowering your taxable income generally is a good idea even if it doesn't change your bracket.
    – rhaskett
    Jan 13 '15 at 22:36

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