The first thing a financial advisor will usually ask you is, “Do you have a retirement plan?”
Yes, you tell them. You plan to be sprawled on a beach, sipping Mai Tais. While that IS a plan, it needs funding. There are several ways to achieve a well-funded retirement, and a 401(k) offered by your employer is one popular option.
But how do you know if it’s any good? And if it isn’t, what can you do about it? Let’s break it down:
First, Review Your 401(k) Plan Fees
Although fees are required to be disclosed by law, understanding them can still be tricky. Some fees are broken down while others are grouped together. There are fees for record keeping, administration, and investment expenses just to name a few. Small businesses with less than 50 employees can expect to pay 1-1.5% on average, but larger businesses should be able to negotiate smaller fees. If your fees cost more than 1.5%, you’re probably paying too much.
Evaluate Employer Contributions to Your 401(k)
Let’s say you’re paying higher fees. Let’s also say you’re in a small to mid-market size business and your employer isn’t capable of negotiating better rates. Those fees can be offset with a higher employer contribution. Anything at or above 6% can offset other poor features like high cost or limited investment options. Employer contributions can be “matched”, meaning you put money into the account and your employer matches a certain percentage, such as 50% of your contributions up to 5% of your salary.
The best plans vest those matches immediately, giving you flexibility to select a new plan or roll it into a qualified retirement plan (like an IRA) when you leave the company. There are other ways an employer can offer contributions, like profit sharing or company stock. Profit sharing is an excellent feature, and is often used as incentive to retain employees. They come with vestment schedules of 5-7 years on average. Company stock is great too, but more stock means more risk. Understand your risk tolerance and determine the right amount of stock that should comprise your 401(k) if this option is available to you.
Separately, the best plans allow you to start saving in a 401(k) plan immediately. Some companies won’t let you, instead requiring you to be with them for a specified period of time before earning the benefit. It isn’t a “bad” plan if you don’t have immediate eligibility. But a full year of retirement savings can result in significant returns long-term, so we do consider this a feature of a good plan.
Understand Your Investment Options
A good plan typically offers enough investment options to adequately diversify your portfolio without providing so many options that you’re overwhelmed. 15-20 funds is typically considered a sweet spot. If your plan offers too few options, the risk to your investment can be significant. If it has too many options, you may experience “analysis paralysis” and choose nothing at all. We also need to add a caution about annuities; they may be right for some investors, but they typically cost more than mutual funds and have less flexibility. Mutual funds may be the most popular, but low-cost index funds can provide superior returns and 60% of all Vanguard plans have at least 4 to choose from.
Ask these questions about your 401(k) benefit before you accept a job offer. If you’re already enrolled in a plan (and you realize it’s not great) don’t worry, nav.igator! You still have control of your retirement. Email your HR rep or CFO and ask these questions:
How does our plan’s cost compare with other plans?
Who manages our funds, and who are we outsourcing administration and management functions to? Can we reduce our fees by changing this?
Does our company outsource or share its fiduciary duty to plan participants?
If your plan looks unlikely to improve, you can still improve your retirement outlook to make sure those retirement Mai Tais are made with premium rum.
(1) If there’s a match, take the match. Even if your fees are excessive, you just can’t find a 50-100% return on investment anywhere else. Do it.
(2) Pay down your debt. Let’s say you have 6.5% interest on your student loans. Paying them off first essentially earns you 6.5% return on that money because you AREN’T PAYING THE INTEREST. This is important to understand, and has to be implemented early on in your investment strategy. Take however much money that interest represents, and invest it. Boom, making returns on returns.
(3) Prioritize other tax advantaged accounts. Traditional or Roth IRAs are a typical option, but you can also consider a health savings account.
(4) If you have a spouse and their 401(k) options are better, consider investing more money in their account.
(5) If you have self-employment income (even as a side hustle) you can check out the self-employed retirement options available to you. Some of them let you contribute tens of thousands of dollars every year.
(6) Use the desirable investment funds in your 401(k) and use your other retirement accounts to make up the shortfall in your investment strategy.
A bad plan isn’t the end of the world. You simply need to be mindful of where you put your money and check out the additional options that are available to you. Save money and do the best you can with the options you have, and you’ll rock that beach life retirement.