A 401(k) may be the largest financial asset a family has. They can be great to build wealth, or so defective they may not be worth your participation. They range from excellent to awful. Unfortunately, it’s up to you to decide whether to maximize the opportunity or pass and find better ways to invest.
Above all, 401(k) plans are investment vehicles and they should be judged accordingly. While there are some tax advantages built in, those can be quickly destroyed by excessive costs, poor performing funds, and insufficient diversification opportunities to allow you to manage risk.
It takes a lot of capital to replace you at work as your family’s income generator. A good 401(k) can be your best ally as you prepare. Or, a lousy plan could destroy your chance of a decent and secure retirement. Now would be a very good time to make sure your plan is up to the challenge.
But, where do you start?
Improved disclosure is on the way
The disclosure you are about to get under the new Department of Labor regulations is a good place to start to evaluate your pension. But, disclosure in a vacuum is worth zero. It’s what you do with the information that counts. If the plan sponsors and participants don’t digest the information, measure against reasonable benchmarks, make informed decisions, and take action to adjust their strategy accordingly, all the disclosure in the world is wasted energy.
The disclosure from each pension service provider to the plan sponsor covers costs, methods of payment, services, fiduciary status, and potential conflicts of interest. For the first time, plan sponsors will have a complete picture of who is getting paid for each service and whether that payment is “reasonable” considering the service provided. Additionally, each service provider must state whether they are acting in a fiduciary capacity which requires them to make decisions solely in the best interests of the plan participants.
Shortly thereafter the plan sponsor will consolidate, summarize and share that information with the pension participants.
Make no mistake about it, this is critical information, and this disclosure requirement is long, long overdue. However, it’s only one piece of the pie. But, let’s start with that piece of the pie as a first screen to see what we should learn, and then work on other parts of the plan to evaluate whether it’s an A+ or F- plan.
The easiest place to start is with costs. There are necessary services that must be paid for by a qualified plan that may make it more expensive to administer than a carefully managed personal account. Record keeping, plan administration, legal, tax preparation, fund expenses, trading costs, compliance testing, accounting, statement generation, web services, custody, and investment advice all cost something. Each cost on its own should be reasonable. But, from the perspective of the participant it’s important that the total expenses not be excessive.
Fortunately, today computers do a lot of the grunt work and economies of scale kick in to make a well run plan very economical. Of course, a plan with many participants and small total assets will be more expensive than a plan with few participants and giant account balances. DOL doesn’t suggest any range of reasonableness for plan expenses, instead they expect plans to occasionally “test the market” to determine what’s reasonable.
As an example, a typical well run very small company plan with $1 million total balances and 50 participants might come in at 1.3% of assets per year total costs. Larger plans should be somewhat cheaper. So, if your plan has total costs that exceed 1.3%, and you pay them, you might want to know why.
It also helps a lot of your employer pays plan expenses directly rather than have them deducted from your account. That can have a dramatic positive impact on the costs you bear and your retirement benefits.
It’s not unusual to come across plans of that size with total cost exceeding 3.25% of plan assets per year which is a devastating tax on future accumulations. In that case, I wouldn’t invest one penny over what it takes to get the match (if any).
Next, you will want to insure that your plan’s investment advisor, administrator/record keeper acknowledge their fiduciary status which would hold them to the highest standards of prudence and the requirement to make decisions solely in your best interests. It’s a total mystery to me that any plan sponsor or participant might consider anything less. If they won’t make decisions in your interest, why would you need them?
Potential conflicts of interest are the next item of concern. As just one example, if an advisor is tied to a single fund family, or to fund families that pay them in revenue sharing arrangements, your universe of potential funds is vastly restricted and your costs may be higher than “reasonable”, and they may tolerate substantial underperformance for extended periods.
Beyond those disclosure requirements there are a number of qualitative considerations that make up a great 401(k) plan. Other plan features are important:
- Enough low cost index funds to effectively and economically diversify your portfolio around the world’s equity and bond markets.
- Predefined target risk and target date solutions to assist you to manage your portfolio to meet your unique situation without requiring you to select individual funds or develop asset allocation models.
- On line tools, calculators and educational material to make number crunching and planning your retirement simple and effective.
- An easily navigated web site allowing 24/7 access to account information, values, performance, loan initiation, investment and contribution changes.
- Periodic automatic rebalancing
- Call centers staffed with helpful advisors.
Take the time to evaluate your plan. Remember, it’s your money going into it, and the investment results will determine whether or not you have a secure retirement. You simply can’t avoid responsibility for making informed decisions. Hopefully, your plan will shine. If not, you have lots of options to be discussed soon.
Frank Armstrong is the founder and principal of Investor Solutions, a Miami-based NAPFA fee-only registered investment adviser with more than $550 million of assets under management. He has more than 38 years’ experience in the securities and financial services industry and has published four books and hundreds of articles on investments and retirement planning. Visit him atwww.investorsolutions.com.
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