For many of us, our employer’s 401(k) plan is our primary retirement savings vehicle. Participating in the plan is generally easy and painless. Your contributions are deducted from your paycheck each pay period, there is nothing that you need to do other than select how you want your money invested. Some companies even offer a matching contribution on top of what you contribute.
Even with these attributes, you still want to be sure that your company’s 401(k) plan is a good one and that it is a good place for your retirement savings. It's important to evaluate the plan in several areas.
A key factor in evaluating your company’s 401(k) is the quality of the investment lineup offered. Quality encompasses several features.
Do the mutual funds or other investment offerings allow you to build a diversified portfolio? Are there funds offered across a range of asset classes and sub-asset classes for stocks, bonds, and a cash option? Does the plan offer several low-cost index funds, for example, an S&P 500 index or one that replicates the total U.S. stock market?
How do the funds compare to other funds in the same asset class? Where mutual funds or ETFs are used you can check on this using a service like Morningstar. The annual fee notice report that you receive from your employer will generally show a comparison of the investments to a benchmark like the S&P 500 or the Russell 2000, but usually not to other funds in the same asset class peer group.
Matching from your employer can help increase your plan balance. This is basically free money. The matching formula might be on the order of a 50% match on the first 6% of your salary deferral contributed to the plan. The higher the match obviously the better.
Another aspect of the employer match is the vesting formula, this refers to the time period in which the company match is yours should you leave the company. A typical formula is that you earn ownership in 20% of the match each year with full ownership occurring after five years with the company.
In addition to a matching contribution, some companies will make an annual profit-sharing contribution to your 401(k) account. These contributions are optional, the company can skip a year if they had a bad year financially or for any other reason.
All of these company contributions serve to enhance your retirement savings efforts beyond your own contributions. The amount that your company contributes to the plan on your behalf is a factor in evaluating the quality of your plan.
High expenses are a major impediment to retirement savers trying to build a retirement nest egg. Studies by the SEC and others have shown that even a relatively small difference in investment expenses can have a dramatic impact on the growth of your investments over time.
Plan expenses come in several forms. There are the expense ratios of the mutual funds or other investments offered. Expense ratios are deducted from the gross returns of the funds the same as with investments in mutual funds made outside of the 401(k).
Some plans may also charge some or all of the administrative costs of running the plan to the accounts of the participants. This is generally done on a pro-rated basis determined by the relative size of your balance as a percentage of the total assets in the plan, but there may be a different formula used in some cases.
Plan expenses are disclosed in the annual fee notice that your employer is required to send to you. You may have to dig through it a bit to determine what expenses beyond the mutual fund expense ratios are being charged to your account. What you will need to do is to look up the fund’s expense ratio in the prospectus that you were given, or in the case of mutual funds, you can do so on a site like Morningstar. If there is a difference between the expense ratio of the fund and the amount listed on the annual fee report, this will represent the plan administrative fees being charged to your account.
If you’ve done your homework and you decide that your company’s plan is not as good as it could be, you have some options. One is to not contribute to your plan or to only contribute enough to receive the full match offered by your company if they do matching contributions. This isn’t the most preferable option as you are missing out on the ability to contribute to a tax-advantaged retirement account.
If you are married and your spouse has access to a good plan through their employer, be sure to max out contributions to that plan.
If you feel your employer’s plan could be improved in terms of the plan’s expenses or the quality of the investment menu, it can pay to voice your concerns to the plan’s administrator or to senior management. Of course, you want to be respectful in voicing your concerns, and you will need to be able to articulate the issues you see. Perhaps it is with the quality of the investments or the costs of the plan. With the rash of participant lawsuits against 401(k) sponsors in recent years, many employers are more receptive to this type of feedback. For many companies having a good 401(k) plan is a vehicle to attract and retain top employees in a competitive job market.
We periodically review our client’s 401(k) plans as part of the financial planning and investment services we provide. The assets in their 401(k) accounts are a key piece of their overall investment portfolio. In the process of determining how they should invest their 401(k) assets, we review the overall quality of the plan to help us make those recommendations.
If you have any questions about your investments, including your 401(k) plan, please reach out.
Bill Canty, CFP®, CPA
Ed Canty, CFP®
Joe Canty, Investment Advisor Rep.
Maureen Walsh, EA, Investment Advisor Rep.
Tina Alteri, CPA, Tax Advisor