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Our Company 401k - When We Should Say No
We spend a lot of time trying to educate folks on how to get smarter about investing, especially when it comes to a 401k plan. There’s one thing we don’t harp on enough, though: sometimes it makes sense to avoid our company’s 401k. Not all plans are created equal – some are decidedly better than others, but some could actually hinder our chances of building a nice, fat nest egg.
More and more employers are moving their workers from the old ‘defined pension plans’ and into 401k plans. Almost 70% of these companies use an ‘auto-enroll’ feature that shoves employees blindly into the plan unless they proactively opt out. The good news is nowadays there are a lot retirement investment options available for working folks outside of a 401k plan…especially a bad 401k plan!
Let’s look at 3 reasons we’d say ‘no’ to our company’s 401k plan:
1. NO COMPANY MATCH – This is a big one. In our opinion, receiving a company match is the only reason to participate in our company’s plan!
What we’d do:
> Open our own retirement account (such as an IRA) at a discount brokerage. Get the benefits of tax-free savings (although contribution limits are less than a 401k plan), payroll deductions, low fees and a huge choice of investment options.
> Even if our company does match contributions, we’d fully invest in that plan – up to the maximum match amount – and then open our own IRA account to invest the rest of our moolah.
Note: Be aware of the vesting requirements of the plan – most participants have to wait 4 to 6 years before they’re fully vested (to have access to the company match). If we move/change jobs a lot, that’s certainly something to consider!
2. CONSISTENTLY HIGHER THAN AVERAGE COSTS & FEES – It’s a given: it costs money to run a 401k plan. Those costs are reflected in the fees paid by the investors (us) and our company (ultimately, us!). When it comes to individual funds, most gurus say we should avoid ones with expense ratios higher than 1%. When it comes to plan administrative fees, the gurus say 1.5 to 2.0% cost ratios are average.
What we’d do:
> In most cases, we’d avoid buying funds that have higher than average fees (they’d better be some awesome performers if we do!). We’d concentrate on the plan’s index fund choices instead since they usually charge the lowest fees.
> For higher than average administrative fees, we’d petition the company to look into getting those fees and costs lowered by negotiating with the plan’s provider.
3. POOR/LIMITED INVESTMENT CHOICES – When it comes to the investment choices offered in 401k plans, the quantity and quality of those choices vary widely. For smaller plans, quality choices are often limited. Even supposedly solid target-date funds (especially the ones auto-enrollees are pushed into) can be poor, expensive performers.
What we’d do:
> It would take some digging, but we’d find 3 or 4 of the best funds available in the plan and put ‘em to work. Since we mainly use index funds, we’d only need a few to create a solid, well-diversified portfolio.
> If quantity and quality are both lacking, we’d petition our plan administrator to make changes. As we said above, they do listen and they do make changes…but we have to be proactive!
One final note: Never totally ignore a bad 401k plan – keep an eye on it. Changes can and do happen within plans, usually as the result of feedback from dissatisfied employees. And it’s happening more often lately. Heck, our company just changed their plan’s provider last month! So keep checking – if our bad plan suddenly becomes more attractive, we can always say ‘yes’.
To access earlier blog posts, click here.
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Here are a couple of very simple retirement calculators courtesy of our friends over at Calculator Pro.
Here are the figures we used:
> Required Annual Income: we put in what we're making now (we don't buy into that "plan to spend 70% of your working income in retirement" idea!)
> Years until Retirement: we shot for age 65, but who really knows, right?
> Years after Retirement: we sure hope to have 20 good years of doing what we want to do!
> Annual Inflation: we used 3.5% (maybe go a tad higher to be safe?)
> Annual Return on Balance: we used 7% (maybe go a tad lower to be safe?)