The 401k plan has become the go to retirement savings account for millions of Americans. But is this really the best option that we can come up with? Should we just blindly trust that this is where we should be saving our hard earned retirement money?
Here are 4 things I don’t like about the 401k Plans…
1. Limited investment choices. Even the best 401k plans rarely have more than a few dozen investment options. I know this is intended to keep participants from feeling overwhelmed, but in some instances it may potentially limits investors.
What’s more is that a lot of 401(k) plans are now pushing people towards these target date portfolios which they’ve touted as the one stop shop, the set and forget it type of investment plan. If you’ve read my blog and some of the other things that I’ve done, you know that I’m not convinced that target date investments are always the best choice.
Target Date portfolios are by far the most popular investment choice for 401k plans and are expected to reach $1.1 Trillion in 2016 according to Cerulli & Associates.
2. Potentially less transparent. Investment portfolios called Collective Trusts have become increasingly popular with 401k plans over the last several years. These are portfolios sponsored by bank or trust companies and are only available to qualified retirement plans. One challenge with them is that they may be less transparent. With some collective trusts, it’s difficult to do your own research. While information is available from the plan provider or product sponsor, there’s generally no ticker symbol that we can track or publicly available third party research.
3. Fees. According to a recent survey by AARP, 7 out of 10 workers believe that they don’t pay any fees on their 401k plan. Fortunately, the Department of Labor has now required that 401k plan’s provide participants with an annual fee disclosure at least once a year.
While some 401k plans have very low expenses. Small company plan’s in particular may have much higher fees than larger plans. If you work for a smaller company, you could be paying nearly significantly more than some larger plans. (See my blog, No, Your 401k is Not Free)
4. Your Money is Locked up. Even if you like your 401k plan now, companies are under no obligation to keep it the same way forever. They can change the match, the investment options, even the provider any time. You, on the other hand are generally required to keep your money invested there until you either leave the company or you turn 59 1/2. While some plans may allow you to rollover a portion of your 401k to an IRA while you are still employed, withdrawals from the plan before age 59 ½ will generally be subject to a 10% tax penalty in addition to ordinary income taxes.
Ok. So 401k plans are not all bad. Here’s a few things they actually do well…
1. Convenience. Many people have trouble saving money. the 401k is set up for employees to contribute money to the plan straight out of their paycheck, before they even see it. If it were left up to them, many people probably wouldn’t save the money.
2. Match. Your employer may offer a matching contribution up to a certain percentage of your income. If they do, you should probably take advantage of it. After all, it is free money.
3. Higher contribution limits. 401k plans have much higher contribution limits than IRA accounts. For 2017, $18,000 per year if your under 50 and $24,000 if your 50 or older. Compare that to an IRA which is $5,500 for those under 50 and $6,500 if you’re 50 or older.
4. No income restrictions. Making a tax deductible contribution to a traditional IRA is very restrictive. If you or your spouse is covered by an employer sponsored retirement plan of any kind, then it could limit your ability to make a tax deductible contribution. There are also income restrictions as well, that affect both the Traditional as well as the Roth.
My dream for the 401k.
Most likely the 401k is here to stay. Those wheels have been in motion for quite some time. My opinion on this though is that people may be better off if they could choose how and where to invest their money for retirement. This would require people to become more financially educated. Not a bad thing.
We already have all the accounts in place. Some things that Congress could change to allow more flexibility.
1. Remove the income restrictions. Allow anyone to contribute to a Traditional IRA and get a tax deduction for their contribution. Or, make a contribution to a Roth IRA. Regardless as to how much money they make.
2. Raise the contribution limits. My choice would be to combine the contribution limit for the IRA and the 401(k) plan together. So if you’re under 50, you could contribute up to $24,000 dollars a year. If you’re 50 years or older, you could contribute $30,500.
I believe this would be a very simple fix that would have multiple benefits.
1. Choice. You could choose where and how to invest your portfolio for retirement. Work with an advisor, or do it on your own. If you change your mind and want to change it, you simply transfer your account from one provider to another.
2. Fees and Costs. The costs for a company to maintain a 401k plan can really add up, especially for smaller companies that don’t have the economies of scale. Asset management fees, per person admin fees etc. not to mention the time and expense of the staff that needs to field questions form employees, deal with the accounting and record keeping.
3. Focus on business. Not having to deal with the time and expense of maintaining a 401k plan can allow the company to focus on more important things, like running a business, product development etc.
If you agree with my opinions on the 401k please share this post. Maybe it will end up in the hands of someone who can push to do something about it.
The opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The target date is the approximate date when investors plan to start withdrawing their money. The principal value of a target date fund is not guaranteed at any time including target date. Investing involves risk, including possible loss of principal.
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