401(k) Tips

Where Does 401(k) Money Go?

If you just started investing in your 401(k), it is important to know where 401(k) money goes. Here is everything you need to know.

3 min read

A 401(k) is one of the main retirement vehicles that American workers use to build up a retirement nest egg. Workers enjoy various tax benefits, and the automated contributions make 401(k) a valuable financial instrument to accumulate retirement savings.

When you contribute to a 401(k) plan, the funds are invested in various investments such as mutual funds, exchange-traded funds, company stock, and other investments. These investments have different risk levels, and they range from conservative to aggressive. However, compared to other retirement plans such as IRAs, 401(k) accounts have a limited selection of investments.

Investment Options in a 401(k)

Most 401(k) retirement plans offer a choice of at least three investments, but the average plan size offers 8 to 12 investment options. Mutual funds are the most common investments in a 401(k), but some plans may also offer exchange-traded funds, company stock, variable annuities, and stable value funds. If the retirement plan offers brokerage accounts, participants can choose different investments such as stocks, bonds, and mutual funds.

If a company offers automatic enrollment in its retirement plan, the employer picks default investments for new employees to invest in. The default investments are often conservative funds that the federal government has approved. An employee can decide to continue investing in the default investments or allocate the contributions to different investments provided in the employer's investment plan.

However, there are different rules on how the employer’s contribution is invested; some employers may decide how the 401(k) match is invested, while in other companies, employees decide how to invest the matching contributions.

Types of Investments Offered in 401(k)

The following are some of the investments commonly offered in a 401(k):

Mutual Funds

Mutual funds are the most common types of investment offerings in a 401(k) plan, and they spread the money across multiple investments. These funds are professionally managed; there are money managers who are tasked with choosing the specific bonds and stocks for the fund’s investors. Mutual funds have different grades, ranging from conservative to aggressive. The average mutual fund has hundreds of securities, and this allows investors to gain diversification at a low price.

The main types of mutual funds include stock funds, bond funds, balanced funds, and target-date funds.

Exchange-Traded Funds (ETF)

An ETF comprises different types of investments such as stocks, bonds, commodities, and other types of assets. These securities are traded on an exchange, just like stock. ETFs have similar characteristics with mutual funds, except that the former is traded on a public exchange and it trades throughout the day. In contrast, mutual funds are not traded on an exchange, and they only trade once a day after the markets close. ETFs are a popular choice for 401(k) participants looking to grow the 401(k) savings.

Company Stock

If you work for a publicly-traded company, part of your contribution may be used to buy the company's stock. This investment option gives employees an ownership stake in the company. If the company has a strong financial performance, employees stand to benefit through dividends and an increased value of the company’s stock. However, if the company shuts down or declares bankruptcy, employees risk losing their investment in the company’s stock.

Individual stocks and bonds

If the 401(k) plan gives you the option of opening a brokerage account, you can use the brokerage account to buy stocks, bonds, and ETFs, which are not available in a regular 401(k) account. Since the 401(k) account is tax-deferred, you won’t pay capital gains on the profit you make from buying and selling securities through a brokerage account. However, you will still pay income tax when you take a distribution from the 401(k) account.

Variable Annuities

Some 401(k) plans may allow participants to invest in variable annuities. These investments are a hybrid insurance company contract that comprises multiple funds that work the same way as mutual funds, but with insurance protections. When you invest in variable annuities, you don’t pay tax on the gains until you withdraw it. However, variable annuities have higher fees than mutual funds.

How Solo 401(k) Can Invest in Alternative Assets

A solo 401(k) allows the holder to invest their retirement money in any type of investment without requiring approval from any custodian. The IRS only provides a list of investments that are prohibited such as life insurance contracts, collectibles, and S-corp. Except for these investments, the participant can invest in any other investment allowed in the plan documents. You can open a solo 401(k) with your preferred broker, and invest in different types of investments, without being bound by the restrictive rules of a traditional 401(k) plan.

Some examples of investments that you can invest in with your Solo 401(k) include:

Real Estate

You can use your Solo 401(k) funds to invest in real estate properties and raw land. One of the benefits of purchasing real estate using a Solo 401(k) is that all gains are tax-deferred, and you won’t pay income taxes until a distribution is taken. For example, if you purchased raw land for $50,000 and sold it for $150,000, the $100,000 in gains will be tax-deferred until you take a distribution.

Tax liens

You can use the Solo 401(k) money to buy tax liens and tax deeds. As the trustee of the plan, you can make an instant purchase without requiring consent from a custodian or other party.

Private businesses

You can use your Solo 401(k) funds to buy an interest in a privately owned business while taking into consideration the IRS prohibited transactions and disqualified persons. For example, you can neither purchase an interest in an S corporation nor use funds from a disqualified person to purchase an interest in a private business.

Precious metals and coins

An investor interested in buying precious metals and coins can purchase these investments using Solo 401(k) money. These investments must be physically deposited at a US depository institution or bank, and not held in the personal possession of any person. Before investing in precious metals and coins, you should confirm if they are on the list of IRS-approved precious metals and coins as provided in Section 408 (m) of the IRS code.

Foreign Currencies

If you are interested in gaining liquidity advantages to the stock market, you can use your Solo 401(k) money to purchase foreign currencies. Any gains earned from buying and selling currencies are tax-deferred until you take a distribution. However, you should take caution when trading foreign currencies due to the high volatility and significant risk that they pose.