Wednesday, April 5, 2017

401K Plans - The Ugly Truth

Employer sponsored plans such as; 401k's, 403b's and 457's can be a great idea for people looking to stash away as much money as possible for their retirement. The question of whether your plan is right for you and your goals can be highly subjective both to you and the plan in question. For this blog, I will predominately use 401K's as the umbrella term for all company/government sponsored plans since they tend to be the most commonly known. However, these characteristics, good or bad, can be applied to any company plan.


The most important question you need to determine is whether your employer will offer any sort of matching contributions. As I've said on numerous occasions an employer match is a must because they're giving you free money. If they do offer a match, then it would be a good idea to find out how much and whether there is a vesting schedule for the plan. A vesting schedule is the employer’s way of "handcuffing" you for lack of a better term, meaning for you to receive the employer match you must stay for a specified time. So, this is one variable to consider if you're in the fortunate position of choosing between two different job offers with virtually identical pay and benefits. Going a step further, unless you're maxing out an IRA there's no reason you should be contributing anything more than what is required to receive your employers match. If you're already maxing out your Roth or Traditional IRA, then you can add additional money to your 401K more than the match.

Fees seem to be a priority for everyone lately and a recent survey found 92% of people believed their 401K plan had no fees. That means, 9 out of every 10 employees contributing money from their hard-earned paychecks thought they weren't paying any fees to be a part of their company plan. Unfortunately, this couldn't be any further from the truth because most 401k's are loaded with fees and have extremely poor investments choices. In fact, many people don't know how the funds in a 401K plan are chosen. The plan selects the mutual fund company who is willing to pay the most to have their funds represented in the investment lineup. A little-known secret is that these fund companies typically try and offer their most unattractive funds because they know there's a greater probability that they will be selected with limited investment options available. I ran into one client who found that if they wanted to select the lowest cost investments offered in their plan they were subject to a 3.5% initial sales charge for each purchase. 3.5% just so they can take advantage of the lowest cost option in their plan!


BUT WAIT, THERE'S MORE! Not only can the fund expenses be outrageous but the plan will also apply a handful of useless fees and give them an important sounding name so that you'll never question their legitimacy. Plan administration fees, asset management fees and individual service fees are just a few of the ones I typically see but I know there are many others. I've heard the fee hurdle can be as high as 3-4% in some plans meaning you need to earn that much of a return before you even start making money. Now, if you're contributing to a plan that offers a match these returns (or lack thereof) can be hidden behind the match you receive from your employer. You may not notice your subpar returns because your employer is making contributions and it's bumping up your balance each year. It's for this reason that I recommend investors only contribute enough to get the match and then allocate the rest of their money into an IRA. If you have plan that has no match, then you should be utilizing an IRA first and only use your 401K if you've maxed out your IRA and still have additional money to invest.


Would you like to know who has the most to lose when it comes to company sponsored plans? Teachers, nurses and anyone else involved in a 403b plan. 403b plans are not subject to the ERISA requirements and therefore their plans tend to be even more excessive with their fees and expenses. Wouldn't you know it, the people educating the next generation and taking care of us when we need it most are left out in the cold when it comes to their retirement plans.

My intention for this blog was not to scare people away from utilizing their 401K's. As I've said before, these can be extremely useful tools in building up assets for retirement but please stay informed and ask your plan sponsor questions. Company plans always seem to slip under the radar when it comes to discussions regarding fees and I think it's because the investor is gravely uninformed. This can be seen quite clearly when you hear of studies that show more than 90% of people believe they pay no fees in their company plan. An advisor can give you comprehensive advice tailored specifically to your unique goals but you don't get that from a company plan so I think it's time these plans start justifying their fees and expenses.

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