How Good Is Your Company’s 401(k)?
Before deciding where to stash your retirement savings, make sure you put your company plan to the test
Before you stuff the bulk of your retirement savings in your 401(k), it’s worth taking a close look under the hood.
Some companies are tinkering with their retirement plans in ways that raise questions about whether a 401(k) is a worker’s best option for building a nest egg. International Business Machines Corp., IBM -0.66% for example, said in December that starting this year, it will make all of its 401(k) matches and other contributions on Dec. 31, rather than during each pay period. This poses several disadvantages for workers: It means missing out on a year’s worth of potential growth in those matching contributions; and those who leave the company before Dec. 15 will forfeit their match for that year, unless they are retiring.
While IBM’s approach is still rare, fully 22% of employer plans surveyed by the Defined Contribution Institutional Investment Association said they intend to restructure their matches in some way. Thus, workers with 401(k)s might do well to look anew at how much they allocate to their plans, how competitive their plans are compared with other retirement savings options, and whether their employers are proposing changes in their plans.
Although it almost always makes sense to contribute enough to get your company match, whether you should put more than that into the same basket depends on how much you’re being charged in administrative fees, the quality of the investments available, and other factors. Alternative baskets for your retirement savings include individual retirement accounts and variable annuities, both of which also can shelter tax-deferred earnings.
Here’s what to look at in your 401(k) to help decide whether it deserves to be the primary focus for your retirement savings:
Total expenses: Seven in 10 workers contributing to 401(k) accounts don’t think they are paying fees, according to a recent AARP survey. But account holders are charged an estimated $60 billion a year for everything from investment management to record-keeping and filing paperwork with the federal government. That’s money they could have used to help fund their retirement.
Total expenses for larger plans should be “well under 1%,” preferably 0.5% to 0.75%, says Mike Alfred, chief executive of BrightScope Inc., a financial-information firm in San Diego that rates 401(k) plans. If you’re paying between 1% and 2% of your assets’ value, you may want to investigate why expenses are that high, especially if you’re in a larger 401(k) plan. And if the costs total more than 2%, contribute only enough to get the full match from your employer and not a dollar more. “It’s really going to be hard to accumulate assets,” he says.
A recent study for the Investment Company Institute of 525 defined-contribution plans, including 401(k)s, found that the median participant pays 0.78% a year. That means the median 401(k) account balance of $18,000 is charged $140 a year.
The Department of Labor requires 401(k) providers in quarterly and annual statements to publish details about fees and expenses for the plan and for individual investments; simplified information about investment options and comparisons of returns, along with benchmark data; and sites online to get more information about the plan and investment options.
AARP also has a free 401(k) fee calculator (aarp.org/401kfees, registration required) that estimates costs, along with the potential impact of those expenses on your account balance at retirement age.
One note: Part of what drives a 401(k) plan’s cost is its size. If you work for a small employer, especially if your co-workers have small account balances, your employer may have a harder time driving a bargain with the financial firms, often called “record keepers,” that administer 401(k)s.
Company match: What exactly is your employer’s match? The answer requires you to find two pieces of information: the percentage of your earnings that your employer will match, in part or in full; and the rate at which your employer will match. About two in five workers are in plans that match up to 6%, and 10% match more than that, according to federal data. Most give you 50 cents for every dollar you put in. About 9% match 51 cents to 99 cents on the dollar, and 36% match at 100%.
Range and quality of investment options: Does your plan offer diversified investment choices, and have its funds generally performed well over time?
You should be able to invest in five to 10 asset classes, including large- and small-cap U.S. stocks, at least one international-stock fund, Treasurys, an intermediate-term bond fund, and a stable-value fund or money-market fund, Mr. Alfred says.
Check your funds’ fees as well. Low fees can be a big contributor to strong performance. Mr. Alfred’s firm has graded costs for investments in large 401(k) plans by asset class. Some of the best rates included less than 0.45% for bond funds and under 0.85% for small-cap U.S. stocks.
Some of the least-costly funds are index funds that aim to track a market benchmark; some actively managed funds have had better returns than index funds over time, but on average they don’t. You can check funds’ returns versus those of their peers on websites including WSJ.com and Morningstar.com.
A red flag should go up if your employer requires you to hold company stock in your 401(k) account—even if it’s for a short time, says Jack VanDerhei, research director at the Employee Benefit Research Institute.
“A mandated lack of diversification, especially in the plan of the company you’re already getting your paycheck from, is troubling,” Mr. VanDerhei says.
Target-date funds: Target-date funds are pegged to a specific year in which the investor expects to retire, and they trim their equity investments gradually as that year approaches, replacing them with fixed-income investments, most commonly bond funds. Many 401(k) plans now use target-date funds as their default option, requiring workers to opt out of them if they want to manage their own investments.
But the asset-management industry still hasn’t settled on how big an allocation such funds should have in stocks at the retirement date, meaning your exposure to short-term volatility could vary depending on the specific target-date fund used. And the average fees investors pay for those funds are relatively high—0.83% on average, compared with 0.79% for all stock funds and 0.62% for bond funds, according to the Investment Company Institute, which tracks target-date funds as part of its “fund of funds” category.
Ms. Greene is a staff reporter for The Wall Street Journal in New York. Email her at firstname.lastname@example.org.