AdviceIQ: Sizing up your 401(k)
When did you last evaluate your company's retirement plan? If you're like many people, your 401(k) or profit-sharing plan constitutes the largest – or at least one of the largest – investment accounts in your portfolio. Here's how to make sure it's the best plan for you:
Many factors help you evaluate your plan, including the total expenses, investment options, guidance provided and your company match.
Expenses. Unfortunately, retirement plan fee structures often lack transparency. Many plans use mutual funds with high expense ratios (maintenance fees). In this arrangement, fees are not explicitly charged but embedded in the reduced performance of the underlying funds. This may lead you to believe your 401(k) plan is free when you actually pay a high cost.
In general, total plan expenses comprise: administrative, record-keeping and custody fees; mutual fund expenses; and investment advisor and participant education fees. Total expenses often range from 1.5% to 2% with many actually exceeding 2%.
These percentages may seem small and their differences even smaller – but even one percentage point can tremendously affect your net return. Consider that for a $200,000 account balance earning 7% annually, the difference over 30 years of paying 2% vs.1% in fees totals a staggering $373,000.
Recent fee-disclosure regulations for company retirement plans mean your company's providers must make this information readily available.
Investment options. At first glance, the more options a plan offers the better the plan seems. But more is not better if the selection doesn't include the option best for you.
For instance, the best plans generally provide a low-cost index fund (which tracks market indexes) in each asset class. The diversification and cost advantages of index funds help them outperform approximately 70% of actively managed mutual funds each year.
Guidance. You, like many people, probably lack the time, expertise or emotional resolve to properly manage a retirement account; a plan that offers guidance may help. Even when your employer or plan manager offers some form of advice, though, you still may not have the market expertise or enough assurance about the advisor's objectivity to feel confident about the investing choices.
A robust plan can address this gap with a target date fund (aka a life-cycle or age-based fund) that automatically adjusts its asset mix to more conservative as investors approach retirement.
Although this autopilot approach seems easy, you still must consider many factors. Low fees loom as important since target date funds' expense ratios vary. Also understand that target-date funds do not account for risk tolerance and are inflexible – make sure you're comfortable with the risk of a particular fund.
Even better: a plan that offers a low-cost and professionally managed portfolio. This provides you with more flexibility and an opportunity to invest at the risk level you prefer.
Company match. Whether you receive a company match or a company profit-sharing contribution, certainly take advantage of this automatic return on your money.
The amount that companies contribute can vary widely. In our firm's experience, plans range from offering no match at all to companies contributing 15% of a given employee's pay. A strong plan matches 3% or more of your pay.
Company retirement plans remain the best way for you to save large amounts of money in a tax-advantaged account. But not all plans are equal and the quality of your employer's plan in these four areas affects how you prepare for retirement.
Ryan J. Klekar, CFP, CTFA, is a wealth advisor and principal at Truepoint Wealth Counsel in Cincinnati, and is a member of the AdviceIQ Financial Advisors Network, which is a Paste BN content partner offering financial news and commentary. Its content is produced independently of Paste BN.