You might be able to beat a 401(k) by investing on your own

I'm a big fan of workplace 401(k) retirement plans. My 401(k) is the largest investment I own. And I'm convinced that part of the reason for the wealth gap in this country is the availability of 401(k)-style retirement plans for the "have" segment and the lack of such programs for the "have-nots."

So when yet another survey touting the benefits of 401(k)s came out  this month, I initially gave it little thought. This one, from Wells Fargo Advisors, like many before it, underscored the positive impact that 401(k) plans can have. Among the 1,200-plus adults interviewed, those with a 401(k)-type plan reported $87,000 in median savings, compared with $10,000 for those lacking access.

"The most glaring difference to me lies in how much people with access have saved for retirement, comparatively," said Joe Ready, head of Wells Fargo Institutional Retirement & Trust, in a statement.

All of which leads to the natural conclusion that having access to a workplace retirement plan is the key to financial success. But that's not necessarily the case.

Anyone with a regular paycheck actually could fare at least as well, and possibly better, investing outside a 401(k) plan ... assuming they mimic the ongoing saving habits of 401(k) investors. Don't think so? Consider how these common benefits of 401(k)s really shake out:

Tax deduction/deferral

When most people invest in a 401(k), the money goes in on a pretax basis and grows tax-sheltered until withdrawn. This is a nice tax break. Nevertheless, when the money comes out, it will be taxed as ordinary income. If you instead invest outside of a 401(k) plan in a low-cost, tax-efficient index mutual fund or exchange-traded fund, your earnings would be mostly or entirely tax-deferred until withdrawn, when possibly much lower capital-gains rates would apply.

Tax penalties

In general, withdrawals from 401(k) accounts made prior to age 59½ trigger a 10% tax penalty, along with the regular tax bite. There are some ways to skirt this penalty, but no penalty applies on non-retirement accounts.

Withdrawal timelines

Eventually, the money in a traditional 401(k) plan will need to come out and taxes will have to be paid. These withdrawals can gunk up the rest of your finances. In particular, if you start making large 401(k) withdrawals while drawing monthly Social Security benefits, the former could be high enough to make some of the latter taxable. If you instead use a non-401(k) investment, you have much greater flexibility in deciding whether, and when, to make withdrawals.

Investment selection

Some 401(k) plans offer a wide lineup of investments, but they won't exceed what you can find on your own. On average, 401(k) plans offer 19 mutual funds or other choices, according to the Plan Sponsor Council of America. Meanwhile, investors outside of 401(k)s have thousands to choose from.

Employer matching funds

This is the one unequivocal advantage of 401(k) plans compared with investing on your own. Many companies offer up to several thousand dollars a year to encourage workers to participate. The most common match cited by PSCA research is 50 cents on the dollar, covering the first 6% of pay. It's free money. However, matching funds are nice, but they usually represent only a modest slice of an account's balance.

So what's the most valuable benefit of 401(k)s? I think it's the ability to have money regularly deducted from each paycheck and invested automatically. The Wells Fargo report touched on this. "The power of automated, systematic saving and investing for retirement through payroll deductions works," Ready said.

But this is not a feature unique to 401(k)s — hundreds of mutual-fund groups and other investment companies will gladly set you up with automatic investing from each paycheck or your checking account.

So if you don't have 401(k) coverage at work, all is not lost. But it does take effort and discipline to set up an automated, long-term investment plan, stick with it and not touch the money too often.

Reach the reporter at russ.wiles@arizonarepublic.com or 602-444-8616.


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