LAST REVIEWED Dec 18 2020 13 MIN READ
By Damian Davila
Since nearly 80% of U.S. full-time workers have access to an employer-sponsored retirement savings plan, chances are that you’ll eventually be eligible to enroll in a 401(k) from your employer. The more employees your company has on payroll, the higher your chances of access to a 401(k).
Seeking to attract and retain talent, most employers offer an employer match as an added benefit. In 2015, Vanguard reported that 94% of its 401(k) provided employer contributions, up from 91% in 2013. So, when faced with the offer of a plan without an employer match, you may think that it’s just not worth it. To help you make a more informed decision, let’s review key criteria to decide whether or not it’s worth to contribute to a 401(k) without employer contributions.
Criterion #1: Level of income
Let’s take a look at two scenarios: high income versus low income.
The high-income case
In 2017, single tax filers with high incomes would still be better off contributing to an employer sponsored 401(k), even without a match, due to three reasons.
First, once you reach certain income thresholds, you’ll no longer be eligible to enroll in alternative retirement plans, such as a Roth IRA.
In 2017, here are the income limits to be eligible for a Roth IRA:
|Tax Filing Status||Modified Adjusted Gross Income|
|Single, head of household, or married filing separately and you don’t live with your spouse at any time during 2017||Up to $133,000|
|Married filing separately and you live with your spouse at any time during 2017||Up to $10,000|
|Married filing jointly or qualifying widow(er)||Up to $196,000|
When you know that your income will continue to be high or you still have plenty of room for income growth, then enrolling in a 401(k) even without match would still make sense to save for retirement.
Second, high earners may find the contribution limits to a traditional IRA or Roth IRA to be too low. In 2017, you can contribute up to $5,500 ($6,500 if age 50 or over) per year to a traditional IRA or Roth IRA. On the other hand, you can contribute up to $18,500 ($24,500 if age 50 or over) to a 401(k) on the same year.In the specific case of a Roth IRA, you may still qualify for enrollment but not be able to contribute as much as the regular limit. Again, your MAGI determines your contribution limit to a Roth IRA.
Here are the Roth IRA contribution limits for 2017:
|Tax Filing Status||Modified Adjusted Gross Income||Contribution Limit|
|Single, head of household, or married filing separately and you don't live with your spouse at any time during 2017||Under $118,000||Up to $5,500|
|$118,000 - $132,999||A reduced amount *|
|$133,000 and over||Zero|
|Married filing separately and you live with your spouse at any time during 2017||Up to $10,000||A reduced amount *|
|$10,000 and over||Zero|
|Married filing jointly or qualifying widow(er)||Under $186,000||Up to $5,500|
|$186,000 - $195,999||A reduced amount *|
|Up to $196,000||Zero|
*To figure out your reduced contribution limit, refer to worksheet on Publication 590-A, Contributions to IRAs.
In 2017, individuals aged 50 and over are eligible to make an extra $1,000 in catchup contributions to a Roth IRA.
Third, individuals in certain income brackets can take a diminished deduction from their contributions to a traditional IRA. Even worse, once your MAGI hits a certain limit, your IRA contributions no longer reduce your taxable income.
Here are the deduction limits for IRA contributions in 2017:
|Tax Filing Status||Modified Adjusted Gross Income||Contribution Limit|
|Single, head of household, or married filing separately and you don't live with your spouse at any time during 2017||Under $61,000||Up to $5,500|
|$61,000 - $71,000||A reduced amount *|
|$71,000 and over||Zero|
|Married filing separately and you live with your spouse at any time during 2017||Under $10,000||A reduced amount *|
|$10,000 and over||Zero|
|Married filing jointly or qualifying widow(er)||Under $198,000||Up to $5,500|
|$98,000 - $118,000||A reduced amount *|
|$118,000 and over||Zero|
*To figure out your reduced contribution deduction, refer to worksheet on Publication 590-A, Contributions to a traditional IRA.
High-earning individuals close to retirement age are much better served by a 401(k), which allows them to contribute $17,500 more than an IRA in 2017.
In summary, earners of high income could benefit from contributing to a 401(k) without employer match because they would be able to contribute more and take a higher deduction.
The lower-income case
On the other hand, workers who are just starting their careers could benefit from contributing to a traditional or Roth IRA instead of a 401(k) account with no match. For example, if your annual salary were only $32,000 and you could only sock away 6% of that for retirement, then you would be anywhere near the $5,500 IRA contribution limit.
In this example, there’s no incentive to stick with the employer-sponsored 401(k) because you don’t benefit from having a higher contribution limit. Additionally, young workers starting their careers have a higher chance of changing jobs several times. So, sticking with an IRA would allow to keep track of a single plan until they’re able to contribute more than $5,500 per year. Having multiple retirement accounts is generally a bad idea, after all.
Even when contributing to an IRA instead of a employer-sponsored 401(k), qualifying taxpayers can still take advantage of the retirement savings contributions credit, also known as saver’s credit. For example, a couple married filing jointly with an adjusted gross income between $37,001 and $40,000 qualify for a tax credit equal to 20% of their IRA contribution.
Another important consideration for those with low income is that when they know that now is the time that they will be making the least money in their lives, they also know that they’re now more likely to be in their lowest tax bracket. When being stuck with a non-matching 401(k) and low income for a couple years, those individuals would be better off contributing to a Roth IRA with after-tax dollars.
Review our comparison of 401(k) vs. Traditional IRA vs. Roth IRA vs. myRA.
In summary, earners of low income, young workers, and frequent job hoppers have no incentive to stick with an employer-sponsored 401(k) without a match.
Criterion #2: Fees
There’s no such thing as a free lunch and retirement accounts aren’t exempt from costs. Savvy investors do well in seeking to minimize the fees and charges in their nest eggs. The investment think tank Morningstar concluded that the annual expense ratio of a fund is the only dependable predictor of future performance, even more so than Morningstar’s own popular star rating system.
Here’s an example for a worker in Oregon. Starting July 2017, some workers will have the option to sign up for a state-sponsored retirement plan named OregonSaves. (To learn more about Oregon, read our report on Retirement Plan Laws in Oregon.) As of February 2017, this plan will be a Roth IRA charging an annual expense ratio of 1%. Let’s imagine that the Oregon worker has two option to save for retirement:
Employer-sponsored 401(k) without match and an annual expense ratio of 0.60%
OregonSaves Roth IRA with an annual expense ratio of 1%
All things kept equal, the employee would still be better off by choosing the employer-sponsored 401(k). If she were to hold a $10,000 balance, she would get charged $100 and $60 in investment fees in the Roth IRA and the 401(k), respectively. Assuming that both retirement accounts offer the same average annual return of 7%, the worker would make an extra $5,880.32 over a 30-year period by choosing the 401(k).
According to one estimate, you have a good chance of beating an annual expense ratio of 0.60% for a 401(k). In 2015, one estimate puts the average 401(k) expense ratio for investing in equity funds at 0.53%.
In summary, compare the total annual cost of your 401(k) without match to those of your alternative retirement accounts and choose the lowest one. Remember that while you have small control over future investment returns, you have total control over future investment costs.
Criterion #3: Investment Options
Generally, a self-managed IRA provides you far more investment choices than an employer-sponsored 401(k). For example, Vanguard’s website states that 105 of its mutual funds and 55 of its exchange-traded funds (ETFs) are eligible for Vanguard IRAs. In comparison, in 2014 the average 401(k) plan offered 25 investment options, of which about 13 were equity funds, 3 were bond funds, and 6 were target-date funds.
Chances are that your employer-sponsored 401(k) without match will have at least one target-date fund. In some cases, it may even only offer target-date funds. While target-date funds are convenient, they aren’t suitable for most investors because these plans charge higher than average annual expense ratios, have variable historical returns, and have one-size-fits-all investment approach. For a full review of target-date funds, read Target Date Funds in 401(k) Plans: Good or Bad Idea?.
According to Thomson Reuters Lipper data, the industry average expense ratio for target-date funds was 0.43% as of December 31, 2015. If your 401(k) plan without match were to limit you mostly (or even worse, only!) to target-date funds, you would be incurring a much higher annual expense ratio that would eat away your investment returns.
In that scenario, you would be better off with an IRA or a request to your employer to consider a transfer to a 401(k) service provider that provides access to lower-cost index funds. For example, Human Interest provides retirement savers access to low-cost Vanguard index funds from every major asset class and risk category, with annual expense ratios as low as 0.05%. In total, Human Interest gives you the option to choose from a variety of low-cost funds.
In summary, choose a retirement account that gives you the most investment options, especially to low-cost index funds.
The Bottom Line: Save, if you can!
Do your homework and shop around for all of your available options for saving to retirement. When evaluating whether or not to contribute to your employer-sponsored 401(k), use your level of income, target annual expense ratio, and desired list of investment funds. The sooner that you start saving for retirement, the closer you’ll be to your nest egg’s target.
If you want to set up or switch to a 401(k) that's great for employees and employers, let your company know about Human Interest.
Related article: Are My 401(k) Fees Too High?
Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.