Is your 401(k) plan good, bad or ugly?
Tuesday, January 08, 2019
401(k) savings plans are a great idea. Within limits, you get to decide how much you’ll contribute out of each paycheck. Regular contributions are relatively painless because they’re made for you by your employer.
Better yet, many employers match whatever you put in. Best of all, the income taxes that would have been due on earnings in the account are deferred until retirement. The money you get to keep each year in your 401(k) that would otherwise have gone to pay income taxes helps grow retirement savings faster. Over time, it makes a big difference.
But while the idea is great, not every plan’s execution of the idea is great, or even very good. The worst plans can deprive you of significant income in retirement. Here are some of the possible problems and what you can do about it.
Who’s Watching Your Money?
Every 401(k) plan has an administrator chosen by your employer. The administrator is an investment firm familiar with all the federal requirements for these plans and, presumably, with the ability to make the best stock investments for your plan.
That’s where the trouble can start. Many 401(k) administrators have close ties with the employing company; especially larger companies and companies in the financial services sector. Contrary to fundamental good investment practice, instead of diversifying your money broadly in the market, the administrator may acquire too much stock in a single company — your employer’s!
This kind of concentration in a single company substantially increases your risk of loss. Worst case, if your company goes BK, your 401(k) investment in that company may disappear entirely!
One frequently encountered problem is that some 401(k) fund administrators have their own mutual fund companies, often with poor track records. Nevertheless, you may find you’re invested in your administrator’s mediocre funds.
A related problem can be the fee structures of these plans. Many investors aren’t aware that the plan administration has no fiduciary duty to make the best investments it can, only that the investments are “reasonable,” a word whose meaning fluctuates broadly in this context. The administrator’s own mutual funds often have higher than average fees.
Investing in those in-house plans isn’t in your best interests, but since it’s a legitimate fund company, it’s still "reasonable" for your fund’s administrator to make those investments on your behalf.
It’s widely agreed among economists that the best way to increase your retirement savings is to lower investment management fees. These high-fee, in-house funds are getting money that should be going to you. This makes a surprising difference in how much you’ll have at retirement.
If you put away $200 a month (normally, you’d increase those contributions as your earnings increased, but for illustration purposes we’ll assume the same amount each month) in 30 years you’d have about $202,000 in your account. But let’s say your administrator’s fees are about 1 percent higher than they would be in a low-fee fund. Now, at the end of 30 years you’ll have about $167,000. That’s $35,000 that could have been in your retirement account.
What You Can Do About It
Every 401(k) scheme provides you with investment options. Admittedly, some give you more and better options than others. But in all cases, you can improve your returns by becoming an active participant in your fund.
The first thing to do is to establish your options. By law, 401(k) administrators have to provide periodic (usually monthly) information about your investments. This information may also be continuously available online. Look for the degree of diversification in your current portfolio.
There is no reason you should have more than a very small investment in your own company. No one is going to think you’re a disloyal employee if you instruct your administrator to sell some or all of your company’s stocks.
Then, buy highly diversified mutual funds or index funds like Schwab’s S&P 500 Index Fund (SWPPX) that holds proportionate shares of all 500 stocks in the index or Vanguard’s Total Stock Market ETF (VTI) that does the same thing for every stock in the U.S. stock market. If neither of these funds is available through your administrator, look for the most diversified domestic funds it offers.
Next, take a look at the administration fees within each mutual fund in your portfolio. It would be nice if your employer diligently kept track of these things to drive down your costs, but, unfortunately, few do. Avoid administration fees any higher than 0.5 percent, but the lower the better.
If you have funds with administration fees of 1 percent or more, get rid of them. You can do better. In the 401(k) plans of some companies, there is also a self-investment option that gives you a considerable amount of freedom to make the investment choices you prefer.
What Else You Can Do
Some employers contribute generously to their employees’ 401(k) with matching funds. Accenture and Comcast both offer to match your 401(k) contributions up to 6 percent of your income. Since most financial planners advocate putting away 11 percent of your salary toward retirement, this is a great way to do it.
ConocoPhillips does even better, with a 9 percent matching contribution. Other companies are less generous, with 3 percent being the average matching contribution among major U.S. corporations. And many offer nothing at all.
If your company is among the best, that’s great. If it’s among the stingiest, it might be a good idea to look for a similar job in a corporation that contributes generously.
If you’re an employee averaging $100,000 in salary over thirty years and contributing 6 percent each year to your 401(k) and those investments earn 8 percent annually, the difference in your retirement account between a company offering a full 6 percent 401(k) match and those offering nothing is over $700,000!
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