Shortfalls of the 401(k)

Derek Bostian, CFP Derek Bostian, CFP

If you work for a large company, you may have a 401(k).  It’s that account that you pay into every pay period that the company may or may not match and is for your retirement one day.

We can thank a few employees from Kodak who approached Congress in the 1970’s for the invention of the 401(k).  They wanted to defer taxes on some of their income (they made a lot) and invest in the stock market.  A few years later, Ted Benna noticed the provision in the IRS code that had been added and decided to begin marketing them.

Ultimately it became a way for companies to eliminate pensions and require American’s to self-fund their retirement.  It was cheaper – so for businesses, it just made sense.

Now we’re stuck with it.  Few companies offer pensions anymore no matter how loyal you are during your working years.  So what can you do to supplement your Social Security one day (if it’s still here)?  Here are common shortfalls of plans that we see and what you may be able to do about them.

1. Leaving your 401(k) at an old employer

If you’ve changed jobs you may have left your 401(k) in your old plan.  Depending on the investments available and costs of the plan you might be better served moving it into your new plan or rolling it over to a Rollover IRA.  If your investment options are limited in both plans,  you can roll the old account to an IRA at a custodian with a bigger investment selection.

2. Not knowing what you’re paying

401(k) plans have expenses to operate that are commonly paid by the participants. There have been numerous lawsuits over the past few years where employees suing their employers for high fees that have helped to bring overall plan costs down.  Make sure you ask about Sub “T/A” fees which can be paid to a third party for the accounting of participant shares.  There may also be servicing fee’s associated with your plan.  Ask your plan’s administrator what your total costs are (all-in) and ask how they can reduce them.  You may be able to get a better deal than you currently have.

3. Set it and forget it

When you started your job and enrolled in your plan, you might have signed up and set your investment allocation and put it in the back of your mind.  You probably get statements or pull it up online from time to time but how often do you go through your current investment options to see if you’re still on track? Maybe your goals have changed?  Maybe the economy is slowing and you’re invested in more risk than you want?  Some plans will offer “Target Allocations” which will typically direct a portion of your wages into stocks and other categories based on what you pick.  Revisiting where your money is going a few times per year is a good strategy that may help you get ahead.

4. Not getting the company match

If you’re fortunate enough to get a company match, try to take advantage of it.  You’ll likely hear you’re giving away free money if you don’t.   We’ve been asked what “match” means. There’s a lot of variations of this but if you make $50,000 per year and the company matches up to 3% of your income then they would put a maximum of $1,500 (3% x $50,000) into your plan.

Another common formula is to match 50% up to 6% of your salary.  Making $50,000 per year, they would match 50% of 6%….confusing right?  $50,000 salary.…6% contribution ($50,000 x 6% = $3,000)…..They match 50% –  their maximum contribution would be $1,500 (50% of $3,000).  You would have to contribute twice that amount to get the full $1,500 match.  If you make extra contributions then they will typically go unmatched.  Try not to give away free money.

5. Borrowing from your plan

In some cases you need a loan and that’s fine.  If you don’t have other funds to use or this one makes the most sense then you can borrow from yourself.  If you’re buying a home for instance, the 401(k) loan may be available to help with a down payment without messing up your loan qualification.  Just realize you have to pay yourself back with interest (usually).  You’ll also lose out on any earnings that your money could make while paying back the loan.

6. Roth or not?

We’re starting to see more Roth 401(k) options within plans.  These allow your contributions to go into a Roth account which allows them to grow and be withdrawn tax free once certain requirements are met.  Who knows what tax rates will be in 20 or 30 years but if you assume you’re going to make more money and tax rates might be higher then consider the Roth.  But, make sure you open a Roth IRA early on too so you can start the 5-year withdrawal clock when you move it out of your plan.

7. Your Human Resources Advisor

When I enrolled in my first 401(k) they gave me a packet of information and a  30 minute meeting with our Human Resources director.  I was 21 or 22 and didn’t have a clue what to ask at the time. She suggested a couple of investment options and I went with it.  Ultimately, she was responsible for all new hires, paperwork, managing benefits, etc. etc. etc. – but she was NOT an advisor.  HR directors have alot of things on their plate and sometimes that includes the  401(k) plan.  If you have questions about the investment options, expenses of those investments, or managing the risk of your investments then seek professional guidance.  Since 2008/2009, we’ve heard numerous stories about soon-to-be retirees who lost so much of their 401(k) that they had to postpone retirement until they could figure out a backup plan.  Don’t let that be you.

If you have questions about your investments and want to talk through them click here to schedule a strategy session with us. We’re here to answer questions and help however we can.

 

Derek Bostian, CFP
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