A good 401(k) plan should be built around your goals, risk tolerances, anticipated age of retirement and expected rate of return. The problem is, many 401(k) plans are laden with high fees and underperforming investment choices, experts warn.
“It is important to review your 401(k) plan at least every three months,” says Keith J. Kormos, senior vice president of private banking for Bankers Trust. “Many 401(k) plans allow for daily online access, but watching frequently will probably not serve you well. Large interim swings in the market often cause investors to react and sell at precisely the wrong times. Your investment portfolio is a long-term investment that over time, regardless of what the market does, should increase in value. When you do look at your portfolio, take a few moments and review your investment returns over time.”
But that might not be so easy. Here’s the problem with the intimidating world of retirement investing, according to the experts at Money Under 30, which aims to help young adults take charge of their money, prioritize financial goals, and choose financial products wisely:
• Many “financial advisors” who sell retirement investments have no legal obligation to put your financial interests first; they can (and will) sell you the product for which they receive the highest commission. (But there are good guys; look for fee-only financial advisors who are fiduciaries, meaning they have to put your interests first.)
• Most 401(k) plans are intentionally complicated and riddled with high fees that enrich investment companies at the expense of your life’s savings.
• These fees seem tiny—one percent here, a quarter of a percent there—but when compounded over 30 years can add up to hundreds of thousands of dollars flowing out of your account.
• To make matters worse, many of the expensive mutual funds in your 401(k) may perform worse than if you invested completely at random.
So what are some of the red flags you should look for to make sure your 401(k) is working for you?
“First, make sure large amounts are not invested in company stock,” says Matt Dana, partner at Quarles & Brady in Scottsdale. “Next, review your options if you terminate employment with the company and make sure you can roll your 401(k) immediately into an IRA. And last, read the fine print to see what options are available if you die and make sure you can integrate the beneficiary designations into your estate plan with the least amount of income tax.”
Another potential red flag could be a lack of information.
“A good 401(k) plan should offer comprehensive education tools to help participants make decisions appropriate for them,” says Tom Swanson, regional relationship management director for Wells Fargo Institutional Retirement and Trust. “If you aren’t receiving regular messaging and required notices from your provider, including good steps to take to save enough for retirement, you could be missing out.”
Swanson says another area to watch is investment choices. Too many funds, too few funds, underperforming funds or the lack of low-cost investment options could also be indicators of areas that may need improvement.
“Drill down to the individual mutual funds, stocks or bonds and compare the investments to other offerings,” Kormos says. “For example, if you are looking at mid-cap mutual fund, get a rating from Morningstar and compare that fund to other mid-caps that your plan provider might offer. It’s also good to know the fees you are paying on your mutual funds. These embedded fees can be substantial on some funds and should be compared to comparable plan offerings that might carry lower fees and higher returns.”
So what happens if your 401(k) plan is underperforming? You may be able to do something about it by lobbying your employer to re-negotiate its 401(k) plan, or change providers altogether.
The experts at Money Under 30 say that even though the 401(k) plan is sponsored by your employer, the plan is administered by a third-party, commonly known as a trustee. That party can be a large investment company, or it can be an individual investment broker. You may be able to determine who the plan administrator is by contacting your human resources department.
“These 401(k) plans are often used to attract the best talent,” Dana says. “As such, look at other companies in your industry to see what benefits are offered — such as the matching contribution, vesting, distribution options, investment options, etc. Then, sit down with your HR person and review these options with him or her and see if they will act as a voice back to the employer to encourage an amendment or restatement of the 401(k) to incorporate some of these benefits.”
But if it comes down to requesting a change in your company’s 401(k) plan, the folks at Money Under 30 say you better do your research so you can make a solid case for the change. You should be prepared to indicate that the funds available suffer from the following limitations:
• Poor performance: That means that the fund or funds available have been under-performing either the market or the related industry class.
• Limited fund selection: The funds offered do not provide for adequate diversification or alternative investment options.
• High fund fees: The fees being charged in connection with the available funds are higher than the industry average. Be sure to look at load fees (if any), commission charges, and 12b-1 fees.
In pointing these issues out, you’re effectively defining the problems that need to be addressed.
“It makes sense for employers to ask alternative providers to review its existing plan in order to compare fees, performance and product offerings,” Kormos says. “Many times when I’m calling on a company regarding its 401(k) plan, I offer a free side-by-side comparison. We even drill down to the embedded fees within mutual funds to give the employer a true overall cost. Also, oftentimes we find the company owner or president serving as the plan trustee, not realizing the personal liabilities associated with that role vs. a corporate trustee. All companies offering 401(k) plans should have and offer robust employee educational meetings. The goal is to improve plan participation and educate employees about the plan’s investment choices, as well as answer questions. Employee meetings should be held annually to catch new employees and answer questions other plan participants might have regarding their accounts and/or enrollment.”
When talking with employers about changing 401(k) plans, experts say you should be fully prepared to present reasonable alternatives. That means offering examples of three or four funds in each asset class offered that exceed the performance or price of the current funds provided. This will not only make it easier for the administrators to make the change over to new funds, but it will also serve as evidence that the existing funds offered are deficient.
“Ask your employer what resources they are using to benchmark the features, services provided and cost of the plan,” Swanson says. “Utilize publicly available research on retirement plan providers to educate yourself and identify top providers with some of the best rankings for customer satisfaction, online and mobile capabilities and advice tools. With that information, you can have a productive discussion with your employer and gain confidence that your plan is working for you.”
IS YOUR 401(k) WORKING?
Here is what experts say to look for in a 401(k) plan to know if it works best for you:
Jack Barry, president and CEO, Arizona Region, Enterprise Bank & Trust: “Plan participants should look for a diverse menu of investment options. Also, look for variety, and a well-diversified plan will have more than one mutual fund company represented on the list.”
Matt Dana, partner, Quarles & Brady: “You should first look to see what the company’s ‘matching contribution’ will be for your volunteer employee deferrals. A dollar-for-dollar match is the best. Look for a variety of investment options and rapid vesting for employer contributions. Also, make sure there are immediate distribution provisions for education expenses and home ownership. And last, it is nice if you can borrow from the plan.”
Keith J. Kormos, senior vice president of private banking, Bankers Trust: “A good 401(k) plan should be built around your goals, risk tolerances, age of retirement and expected rate of return. … It is also important that once you paint your retirement picture that the dream is reconciled against your estimated income stream and it is equally important to reconcile your investment strategies to your risk tolerances. Low risk equals lower returns and of course the higher the risk the higher the returns, but a greater chance of losing all or a portion of your investment … A great rule of thumb is to lower your portfolio risk the closer you get to retirement or as you age.”
Robert Nichols, financial advisor/CMFC, Desert Schools Financial Services: “Some of the key things to consider when evaluating a 401(k) plan are the employer contributions, vesting schedule, fee structure and investment options. Check if the plan offers both Traditional and Roth versions. The Traditional 401(k) can help save taxes now, but will be taxable when withdrawn. The Roth 401(k) receives after tax contributions that may be withdrawn tax free later.”
Tom Swanson, regional relationship management director, Wells Fargo Institutional Retirement and Trust: “Plans should be easy to use and encourage participants to start saving as soon as possible. Effective plans often utilize auto features that get participants saving as soon as they are eligible and allow participants to increase their contributions automatically. Appropriate diversification of investments is also critical, so investment options available to participants to allow for diversification are critical to success.”