Should you participate in a 401(k) plan that doesn’t match?

Yes!  Anyone who is not in dire straights with their finances should invest in their 401(k), even if their company does not match a single penny.  The tax savings makes investing in a company's 401(k) a smart investment decision for almost everyone.  Not only do savers get to put money in their qualified retirement account before the IRS gets their share, but the money invested grows tax-free until it is withdrawn.  See table below.

Some employees complain their 401(k) isn't good and isn't worth investing in.  "Good" can be a relative term.  It's rare that any of these complainers have done much, if any, research on the funds offered or the alternatives.  I've found, more than not, these complainers are not investing at all and this is simply another excuse to avoid preparing for the future.  While the fees might be higher than you'd like (and usually are) or the fund choices aren't the best (and usually aren't) the alternatives are worse.  These complaints can be valid and the situation can be remedied if the issues are brought to the correct person in the company along with a solution.  The "plan sponsor", typically someone in HR or the CFO, is a fiduciary to the plan and the employees.  This means he or she has a responsibility to have reasonable fees and diversified investment choices, among other duties.

A simply written, professional email requesting the reason why advisor fees are so high (over 1.0%) or why the fund choices only include mutual funds with high expense ratios (over 0.50%) can start the process of improving a 401(k).  Any such email should include examples of alternative investments, such as index funds with expense ratios under 0.10% and an alternate advisor (such as AF Capital Management, of course) that charges only 0.50% in advisor fees for 401(k) plans.  AF Capital Management is not the only advisor that offers lower fees without reducing services.  Anyone interested in changing their 401(k) should give the plan sponsor as much information as possible to make their job easier.

Plan sponsors are not trying to create a bad 401(k).  Many are given this responsibility without being qualified or interested in learning what makes a good 401(k).  Others understand how to make the 401(k) plan better, but don't have the time to make it a priority.  Employees have the right to request improvements or the plan sponsor could be sued.  That is rarely the best option, but is good to know the regulations favor employees.  By offering a solution, an "activist" employee can help everyone in the company have a better retirement plan and save research time for the plan sponsor.

If you hit a roadblock and cannot affect changes in your retirement plan, it could still be better to contribute than not.  Other than changing to a better company, the alternatives do not offer comparable benefits.  Investing in an IRA is one such alternative.  IRAs allow savers to grow their investments tax-free until monies are withdrawn.  Contributors maintain control over their investments and have thousands of choices.  However, investments in an IRA are not tax deductible if the employee or his/her spouse has access to a 401(k) and they make more than $112,000 per year and file as married filing jointly.  In fact, limitations start on employees as soon as they hit $58,000 in modified adjusted gross income if they are single or filing as head of household.  The difference in contributing after tax versus before tax can be more than 30%.  I have yet to see a 401(k) that is worse than starting with 30% less invested.

Finally, consider how long you plan to be with your employer.  Many employees born after 1960 do not stay more than five to six years at any one company.  When you leave a company, you can take your vested 401(k) balance and roll it over into an IRA with unlimited investment choices.  (All employee contributions are vested immediately.)  Even a "bad" 401(k) is worth participating in for half a decade.

The following table shows the difference in growth potential between two accounts.  One invests $10,000 before taxes and then gains 8% each year without being taxed.  The other invests $10,000 after paying 30% in taxes (aka $7,000) and gains 8% per year, but losses 30% of those capital gains to taxes each year.  In less than 20 years, the tax deferred balance is worth more than double what the taxed balance would be.  The difference grows each year allowing the person who saved before taxes to retire years before the taxpayer.