There are pros and cons to having a workplace 401k plan.  It is an option people have to shelter some income, and options are always good.  And unlike Social Security, you are not forced to participate in it.

Still, 401k plans are widely touted as great investment vehicles, even by the establishment media.  Any time something is this widely praised, you should proceed with caution.

First, there is the issue of potential confiscation.  With ballooning government debts and unfunded liabilities, the U.S. government is going to be looking to get its hands on extra money more desperately than ever in the somewhat near future.

I don’t think outright confiscation is likely because of public opinion.  There are tens of millions of people with 401k plans now.  If there is any attempt at confiscation, it will be more indirect.  It will come in the form of higher marginal taxes, higher fees, bigger penalties for early withdrawals, and perhaps fewer choices.  The government may try to push people into “government-guaranteed bond funds” or something of the sort.  The only guarantee is that it will be a ripoff.

A second downside of 401k plans is that you are typically limited in your choices.  You generally can’t invest in individual stocks, ETFs, or options.  I will get to the other downsides later.

We know the advantages of 401k accounts.  They are a way to shelter income and capital gains from income taxes.  Sure, you will eventually have to pay, but there is no question there are strong benefits to this in choosing when to take your income.  You are also not getting hit with the taxes on the reinvested capital gains and dividends.

I often hear, especially from the “experts”, that if your company matches your contributions, you shouldn’t throw away free money by not contributing.  If your company contributes 3% of your income when you contribute 6% of your income, then we are told that you get a guaranteed 50% return.

But I would like to make clear that this is a one-time return on your contribution.  You aren’t continuing to get that return on your money.  The only return is on new contributions.

While this seems to be an unbeatable return, you need to consider your own circumstances and opportunity costs.

One of the major downsides of a 401k plan is that you are tying up your money.  If you still work for the employer that sponsors your 401k plan, then you typically can’t withdraw that money if you are younger than 59 and a half.  You may be able to get a hardship withdrawal (difficult) and you may be able to get a loan.

If you have most of your money tied up in a 401k account, you won’t be able to access most of it.  Are you going to quit your job in order to gain access?  And if you do leave your employer, you are going to then pay income taxes plus a 10% penalty for early withdrawal, assuming you haven’t yet reached the government-designated age.

In other words, this is all part of the nanny state.  You aren’t allowed to access your own money and you have limited investment choices. We wouldn’t want you making the wrong decisions.

Imagine someone in 2011 who had $300,000 in a 401k account with little else in the way of financial assets.  That person wants to buy a house, plus an additional investment property.  This was at the bottom of the housing bust when prices were really low.  But he doesn’t have the money to do so.  He doesn’t have a down payment or money for closing costs and other expenses.

If he had been able to access some of this 401k money, he could have bought houses at the bottom of the bust.  His return at this point would be a lot higher than having invested in mutual funds.

Better yet, imagine someone who wants to start a business and needs some capital, but doesn’t want to take on risky debt.  If all of his money is tied up in a 401k, he is out of luck, unless he wants to quit his job and then pay a penalty for early withdrawal.

The point here is that you have to consider your opportunity costs.  For some people, maybe putting a lot of their money in their retirement account is the best option.  Still, I would recommend it only up to the employer match.

But for someone young and innovative, you might want to consider keeping some money outside of your retirement account where you can access it.  I understand that some people will squander it on luxury items or things they don’t really need.  But even here, who am I to judge?  Maybe it is something that brings them great pleasure.

I know there are people though who can use liquid capital to fund a venture that will eventually pay great dividends in the future.  This could be real estate, gaining a new skill, starting a business, or investing in a start-up.

You have to make this decision based on your own personality and circumstances, but I believe it is always a good idea to have at least some money sitting outside of retirement accounts.  And make sure you factor in the opportunity costs of tying up your money.