Q. I'm considering opting out of my 401(k) plan at work due to the lousy investment selections offered within the plan. I work for a small company, and they use one fund family, and the funds are average to poor performers, and have a 5.5 percent front-end sales load and high expense ratios. I'm single and have a pretty good salary for my age, and can afford to put money away for retirement. I've been told that I couldn't make a tax deductible contribution to an IRA but could make either a nondeductible IRA contribution or maybe a Roth IRA contribution. Which do you think would be better, or should I just participate in the 401(k) plan?
Determining the correct answer to your question is more complicated than you might expect. I can provide you with some thoughts that should assist you in coming up with the right decision for your situation. You may also want to consult a knowledgeable, objective financial adviser.
If the investments offered have high expenses and are poor performers, you must not be the only one disappointed with the company 401(k) plan. Plenty of no-load mutual fund families and discount brokers, such as TD Ameritrade, Charles Schwab and Fidelity, provide 401(k) plans to small companies. You may want to do some research and approach the owner about changing the plan for the benefit of all participants, which would of course include the owner. This may not work if the current provider is a friend or relative of the employer or is providing other services at no charge in exchange for the business.
If your employer doesn't want to make a change, ask about breakpoints. Many mutual fund families charging front-end sales loads will charge lower sales loads on larger investments. If they offer breakpoints, you'll want to know how the fund family establishes eligibility for breakpoint discounts and the breakpoint amounts. Generally, as the purchase amount increases, the discount of the front-end load increases. Many fund families will allow purchases of any fund within the family to count toward the breakpoint amounts. Some also will allow purchases by certain related parties, which may include all participants in a qualified retirement plan. Once you know the breakpoint rules, the front-end sales charge may be much less than you think.
If your employer provides a matching contribution, determine whether it offsets the high fees and less-than-stellar performance of the funds.
A tax deductible IRA contribution is an option for all at any level of earnings if they and their spouses are not covered by workplace retirement plans. Since you are single, if you don't participate in the company 401(k) plan, you can make a tax deductible contribution to an IRA of as much as $5,000 ($6,000 if 50 or older). If you participate in the plan, the deduction is phased out for singles with modified adjusted gross income of $56,000 to $66,000. For those married filing jointly, the deduction is phased out when MAGI is $90,000 to $110,000. For those married filing jointly where the contributor is not covered by a workplace retirement plan but the spouse is, the phase-out range is $169,000 to $179,000.
You can always make a nondeductible IRA contribution, but a Roth IRA is a much better option. If single and your modified adjusted gross income is more than $122,000 ($179,000 if married filing jointly), you can't make a Roth IRA contribution. You could make a nondeductible IRA contribution and immediately convert it to a Roth IRA. This works best if you do not have any other nonqualified retirement plans, such as a rollover IRA. A consultation with an adviser will clarify the tax implications of an immediate conversion for your personal situation. Roth IRAs are usually better than tax-deductible retirement contributions if you think you will be in the same or higher tax bracket in retirement.
