Peaceful Wealth: What to do with your 401(k)
Saturday, May 2nd, 2009
R. Scott Maxwell, MBA
A 401(k) account is the predominant retirement savings vehicle for millions of American workers.
Unfortunately, it may also be one of the least understood.
I am continually surprised by the number of clients who leave their 401(k) accounts in the hands of previous employers once they change jobs or retire. There seems to be a commonly held belief that certain employers offer a unique investment experience within their plans. Employees are reluctant to relinquish the perceived benefits of the plan once they move on. They may not work at the former employer anymore, but they still want to reap the rewards and be part of an exclusive investment club.
Nonsense!
Don’t misunderstand me. A 401(k) plan is a wonderful way for employees to save for retirement. Your contribution levels are usually higher than a traditional IRA, meaning you can save more - and therefore have more - money for retirement. You contributions are made with pre-tax dollars, reducing your taxes today and allowing you to save a larger portion of your gross income. Company matching programs enable you to leverage your contributions and greatly enhance the value of your retirement account. 401(k) investments grow tax-deferred, meaning your money works harder for you and compounds without the headwind of taxation.
These are all tremendous advantages and offer real value to any employee. Unfortunately, many people mistakenly believe the investment choices within their 401(k) plans are equally as valuable. Frankly, they are not.
There are three fundamental problems with most 401(k) plans; they are painfully expensive, they significantly limit your choices and little, if any, professional advice is available to participants.
Painfully Expensive
The Department of Labor’s Employee Benefits Security Administrations lists the following fees you incur in your 401(k):
- Plan administration fees (operations of the 401(k) plan)
- Investment fees (indirect costs charged by the mutual fund managers)
- Individual service fees (special charges for addition plan options)
- Sales charges (loads and commissions on the funds within the plan)
- Management fees (account maintenance or investment advisory services)
- Other fees (anything else)
So, how much will all this cost you? Not knowing puts you in good company. According to Kiplinger.com, “A recent study found that more than 80% of 401(k) plan participants were unaware of how much they were paying in fees associated with their company’s retirement savings plan.” BusinessWeek reported in an article “401(k)s: The Hidden Fees” the overall expenses of most 401(k) plans drain away between 2.5% and 5% of your account value each year. These fees go unnoticed in good times, but the long-term pain they inflict is equally harmful regardless of market conditions.
Limited Choices and Flawed Strategies
Almost all 401(k) plans offer a very limited list of investment options. You have no choice in the matter. You must select what is offered and pay all the commissions and absorb all the costs of each fund you choose. What’s more, rarely can you craft a broadly diversified portfolio based on the principles of passive management and modern portfolio theory. There might be an S&P 500 index fund on your list, but good luck finding other asset classes or avoiding the high fees and annual under performance experienced by the majority of the actively managed mutual funds offered in the plan.
Absence of Professional Advice
You would never know it based on the high fees and limited choices of most plans, but the Employee Retirement Income Security Act (ERISA) requires 401(k) plan sponsors to put your best interests first. This fiduciary standard is mandated by federal law and enforced by the courts. Unfortunately, plan sponsors and plan providers frequently avoid any potential liability by providing only the most basic advice on how to buy your funds without providing any specific advice suited to the individual needs of the participant.
“So”, you ask, “What’s the bottom line?”
Once you leave a company or retire, the vast majority of an old plan’s unique benefits are no longer available to you. The disadvantages of high costs, limited choices and lack of professional advice are no longer offset by the advantages of a company match or larger pre-tax contributions.
Your best option is usually to convert your 401(k) savings into a traditional IRA or Roth IRA (if you qualify for a Roth conversion). You can then decide how to manage your money, what fees you want to pay and who you will entrust with your retirement savings.
R. Scott Maxwell, MBA is a Vice President and a wealth and income solutions expert at Talis Advisors, a wealth management firm headquartered in Plano, Texas. He is committed to teaching investors the truth about the stock market and how they can achieve Peaceful Wealth throughout their lives. Scott can be reached at 972-378-1794 or 866-608-2547 or via his web site at http://www.talisadvisors.com