All 401(k) plans are not created equal. Some employers are more generous with matching contributions; others sponsor plans with mediocre investment choices. And some employees pay much higher plan fees than others. Here are answers to some of the most frequently-asked questions I get on how to best take advantage of a workplace 401(k) plan.
Are the fees in my plan reasonable? Unseen fees charged to investors in plans are one of the biggest variables in fund performance. especially at smaller companies. These include investment product fees, administration and record-keeping fees and other fees for investment advisory services, insurance and auditing.
Nothing affects long-term retirement portfolio success more than fees. A 2010 Morningstar study found that fees trump performance as a predictor of success, with low-cost funds turning in much better returns than high cost funds across every asset class from 2005 through March 2010. The lowest-cost domestic equity funds returned an annualized 3.35 percent over that period, compared with 2.02 percent for the most expensive group.
Fees vary widely among retirement plans — anywhere from well below 1 percentage point to a whopping 5 percent. Yet 71 percent of retirement
savers don’t think they pay any investment fees at all, according to a recent AARP survey.
Brightscope has assembled the industry’s most comprehensive database of 401(k) performance. They’re assigning a simple numerical rating to all the plans–including the ones mentioned above–and making the scores available to investors for free.
Also greater transparency will be coming to your 401(k) plan this year in the form of new quarterly reports that clearly disclose the fees you pay on investments.
The new reports will turn up no later than the second quarter, and you’ll see information about fees being charged to your plan – and the actual dollar amounts charged against your own account and mutual fund choices.
My plan offers Target Date Funds. What are they, and should I use them? Target Date Funds (TDFs) invest in a mix of assets with the aim of reducing equity exposure as participants approach retirement. Let’s say you expect to retire in 2030; you could participate in your fund provider’s 2030 TDF series. The use of TDFs has accelerated sharply in recent years, partly due to the growth of auto-enrollment options in workplace plans, which often default plan participants into TDFs.
The main strength of TDFs is that you can “set it and forget it.” TDFs automatically re-balance to keep you in the proper mix of equities and fixed income. TDFs have been criticized for maintaining levels of equity exposure too high for older investors, and for steep fees. There’s some evidence that target date funds are improving their performance in both of those areas.
I just started working recently, and I don’t make much money yet. What can do to start saving for retirement now? There’s plenty you can do — because time is on your side. Workers in their twenties and thirties have plenty of time to benefit from the magic of compound returns and to allow the market to bounce through its usual ups and downs.
Above all else, get an early start. Nothing will have a greater impact on your success, due to the effects of compound returns over time. This will be true if historical market returns continue – even if you start small and even if there are bumps in the road.
The early start also is a very effective strategy if you’re worried about how much you can set aside.
Vanguard Investments tested scenarios and investment strategies for investors age 25, 35 and 45, aiming for a retirement age of 65. The investor who starts at age 25 with a moderate investment allocation and contributes 6 percent of salary will finish with 34 percent more in her account than the same investor who starts at 35 – and 64 percent more than an investor who starts at 45.
Put another way, the 35-year-old would need to boost her contribution rate to 9 percent to achieve the same result as the 25-year-old starter who was saving 6 percent.
Starting early may permit a lower rate of saving – but that doesn’t mean you shouldn’t sock away as much as you can handle comfortably. Vanguard found that the contribution rate – along with the early start – has a much larger impact on retirement success than market returns.
Higher contribution rates also are useful if you’re scared by stock market risk and prefer a less aggressive portfolio. Vanguard found that a retirement saver starting at 25 saving 9 percent of salary annually with a moderate allocation finished with 13 percent more than by contributing 6 percent in an aggressively-invested account.
Don’t cash out your 401(k) when changing jobs, no matter how small the balance. This interrupts the flow of compound returns and it’s very difficult to make up lost ground over time. Instead, roll over the account to your new employer or a low-cost stand-alone IRA, or leave it in place if it’s a good plan.
Make sure to contribute enough to max out any matching contribution from your employer; otherwise you’re leaving free money on the table. Research by Aon Hewitt found that 43 percent of workers in their 20s contribute to 401(k)s at rates too low to capture the full match, compared with 29 percent of all workplace savers.
Finally, consider using a Roth. Your workplace plan may not offer a Roth option, so consider contributing to a stand-alone Roth IRA with funds over and above your employer match.
My employer enrolled me automatically in our 401(k) plan when I started my job. Is there anything else I need to do? Take a look at the default investment that you were placed in; if it’s a TDF, decide if that’s where you want to stay. More important — your default initial contribution rate probably is too low. Most often, it’s around three percent — and that is not enough to build real retirement security. Consider boosting your contribution as high as you can with comfort — and at least make sure to capture 100 percent of whatever matching contribution your employer offers.
How much can I contribute to my 401(k)? Employee contributions in 2012 for 401(k), 403(b), most 457 plans will be limited to $17,000; the limit for 2013 will be $17,500. The catch-up contribution limit for those aged 50 and over remains is $5,500. More details are available at the Internal Revenue Service website.
My company’s stock is offered through our 401(k) plan. Should I own it, and if so, how much? Plenty of big corporations still have heavy concentrations of their own stock in retirement plans; in some cases, the heavy concentrations are the legacy of earlier employee stock ownership plans, or companies that use their own shares to provide matching contributions. Towers Watson research shows that 78 percent of Fortune 100 employers who allow employees to hold their own shares don’t limit their holdings.
Yet volatile financial and employment markets point strongly to the need for retirement investors to protect themselves — no matter how attractive an employer’s stock may look. If more than 20 percent of your account is in company stock, it’s likely to be too high–and some financial advisors think you should limit holdings in your employer’s shares to the five to ten percent range.
If you’re too heavily concentrated, your employer’s plan may offer an advice program that can help you develop a plan for selling down to a more appropriate level.
Is it ok to withdraw money from a 401(k) early, or take a hardship withdrawal? Account balances in 401(k)s grow most effectively over time, but about 45 percent of plan participants cash out their 401(k) balances when they change jobs rather than roll them over to new employers or IRAs. That disrupts the long-term growth of their assets.
Borrowing and hardship withdrawals also are allowed under the rules, and people have been tapping into their balances somewhat more frequently during the recession. The government tries to discourage this behavior by imposing a 10 percent penalty fee on withdrawals before age 59½. Borrowing from a 401(k) may seem like a good option if you are hard pressed by hard times, but loans or withdrawals inflict serious damage on portfolios because you lose the opportunity to earn a return on the funds that are withdrawn.
Also lost is the opportunity to earn returns on new investments; in most cases, you can’t make contributions while you have a loan outstanding, and you can’t contribute for six months after you make a hardship withdrawal.