There’s a lot to like about employer-sponsored retirement plans like the 401(k): They’re convenient (funded via automatic payroll deduction), offer tax savings (contributions lower a participant’s taxable income, and investments grow tax-free) and many companies sweeten the deal by pitching in their own money to encourage employees to save.
But even this valuable perk can be ruined by high retirement plan fees and crummy investment choices.
Investors should take a closer look at their workplace retirement plan. Here’s what to look for:
Quality. The quality of a 401(k) comes down to the breadth of investment options, the management fees charged on those investments and the plan’s administrative costs.
Unfortunately, if you work at a small company, the terms in your plan may not be the best.
According to research from the Investment Company Institute and BrightScope, the average 401(k) offers 25 investment choices. That’s more than enough as long as the menu of funds includes all the ingredients necessary to build a well-balanced retirement portfolio — a diversified mix of stocks, bonds and cash — at a reasonable price.
Array of mutual funds. The best 401(k) plans offer an array of low-cost mutual funds that let investors cover as many bases as possible.
Even then, some savers may find the choices too limited for their needs. In that case, an individual retirement account can be used to fill in the gaps.
The markups. What is the markup on the mutual funds in the plan?
A plan offering plenty of funds, but only of the high-priced variety, is no better than a plan with limited offerings.
A good rule of thumb is to steer clear of any fund with an expense ratio of 1 percent or more. And although index mutual funds are known for their low fees, beware of expense ratio markups there, too.
Go directly to the source for this information (via your plan’s 401(k) prospectus or the administrator’s website) since the expense ratio on a fund purchased in a 401(k) may be different from what’s posted on a fund company’s own website.
Who pays? Most companies outsource the logistical care and maintenance of administering a 401(k). You might be picking up the tab. It’s up to your boss to decide.
The plan’s fee arrangement details are disclosed in the 401(k) summary plan description or annual report. The most generous companies pay the entire bill. Others cover only a portion. The mark of a subpar plan is one that asks workers to foot the entire bill.
WHAT TO DO WITH A DUD
- If your 401(k) plan is truly bad — and you don’t get an employer match on your contributions — direct your initial retirement savings dollars into a self-directed IRA and max it out before turning to the 401(k).
- Look for an investing escape hatch: Some 401(k)s include a brokerage window — the option to open a self-directed account within the plan — which opens up the world of outside investment choices.
- Put on your activist cap and lobby for improved conditions for everyone: Talk to your human resources department, benefits committee or even the chief financial officer to push to include lower-fee investment options in the plan.