Since the development of the first defined contribution retirement plans in the late 1970s—based on provisions of Internal Revenue Code Section 401(k)—the 401(k) has become the primary retirement savings vehicle in the United States. At the end of 2016, 401(k)s and similar plans for government employees and non-profit employees accounted for $7 trillion in retirement savings. Yea, that’s trillion with a “t.”
Most U.S. workers rely solely on 401(k) assets and social security distributions to support their eventual retirements. With that in mind, we think it’s a shame that most 401(k) plans are not well aligned with the needs of participants. We think individualized education and counseling needs to be a part of any plan because the complexity of 401(k) decisions can be overwhelming.
Employees face a bewildering number of choices with their 401(k)s. How much should I contribute? How much can I afford to contribute? Should I pay off student loan debt before participating in a 401(k)? Should I do a Traditional or Roth 401(k)? How should I allocate my funds across stocks and bonds? What specific funds are best for me? Our work with hundreds of financial planning clients leads us to believe that very few 401(k) participants get adequate, effective education to help answer these questions.
The complexity of 401(k)s can be equally daunting to company sponsors tasked with selecting advisors, record keepers and fund line ups. Many 401(k) expenses are not well understood by sponsors and the fees passed through to participants are often higher than necessary. For an employee with a $50,000 balance in their 401(k), 25 years until retirement and an expected investment return of 6%, fees that total 1.5% of assets versus fees that total 0.5% of assets would reduce the account balance at retirement by more than 20%.
While 401(k)s have become a staple of employee compensation packages, 401(k) plans are too often viewed as check-the-box offerings rather than differentiated benefits that can positively impact recruiting, retention and employee wellness. We’d like to see sponsors become more proactive in periodically evaluating their options.
Most importantly, we think that individual participants should take an active interest in their 401(k) plans and advocate for changes when appropriate. What should you, as a 401(k) participant, ask your company to do?
Provide real financial education to your employees. Make sure that your employees receive individual counseling that addresses a range of personal financial topics, including household budgeting, student loan consolidation and mortgage refinancing. Individual one-on-one counseling with a non-conflicted advisor can positively impact 401(k) savings rates and employee well-being.
Evaluate your plans expenses and move to a flat fee structure. Most traditional 401(k) advisors charge a percentage of plan assets so the fees naturally increase as assets grow over time. Negotiate a flat fee based on the number of active participants, and make sure you understand how the fee equates to actual hours of work performed in servicing the plan. If your fees are bundled, make sure you understand how the charges are allocated to record keeping fees, fund management fees and advisor fees.
Provide low-fee, passively-managed investment options. According to a recent S&P Dow Jones study, more than 90% of actively managed U.S. stock funds underperformed their passively-managed equivalents over a 15-year period. Portfolio managers are not bad at picking stocks, but they are hard-pressed to pick stocks that beat the market by wide enough margin to offset the fees the funds charge. Most 401(k) participants should invest in an age- and risk-appropriate portfolio of passively-managed stock and bond funds. Target-date funds—with asset allocations based on planned retirement dates—are often a simple and effective way to assemble an appropriate portfolio of assets.
Look for highly credentialed advisors. The investment industry is infamous for an alphabet soup of confusing credentials. To cut through the confusion, there are two gold-standard designations to look for: Chartered Financial Analyst (CFA) and the Certified Financial Planner (CFP). The CFA represents a deep understanding of investments. The CFP represents a deep understanding of financial planning.
Cast a cynical eye on advisors with clear conflicts of interest. Many 401(k) sponsors work with insurance brokers or stock brokers to act as the advisor to their plans. We’d note that many of these advisors have been fighting new, pending Department of Labor rules compelling them to act as fiduciaries, or in the best interest of their clients. It is perhaps more troubling, however, that these financial services are starting to call themselves fiduciaries when many conflicts of interest remain. Just because your advisor’s compensation is based on annual fees rather than commissions, doesn’t change the fact that an insurance broker is looking to sell insurance and a stock broker is looking to sell stock. Look for an advisor that doesn’t sell financial products. Period.
Don’t be afraid to change. Perhaps the biggest barriers to evaluating a change in your 401(k) plan are inertia—“if it ain’t broke, don’t fix it”—and entrenched, long-term relationships—“our current provider does a great job.” With employees increasingly relying on 401(k) assets to support their retirements, 401(k) sponsors owe those employees a diligent and dispassionate review of the plans. The stakes are too high to ignore. At minimum, 401(k) sponsors should go through a formal evaluation process every three years.
For most participants, 401(k)s are a bit of mystery. We wouldn't expect you to become an expert, but we think it's in your best interests to take an interest. Question authority.