3 Ways To Tell If You Have A Good 401K Plan

 

 

 

 

 

 

401k and 403b plans have gotten a bad rap in the press – especially lately.  As the 401k replaces the defined benefit plan as the primary retirement savings vehicle for many, we are learning that many of these plans have high fees and under-performing funds.  And because the 401k or 403b has no guarantees, this is of concern.  But like anything else – some plans are better than others; so here are 3 ways to tell if you have a good 401k plan or not:

1) It has a match: A match is free money for participants – so obviously that is one sign of a good 401k plan and will improve retirement outcomes.  The most common match formula is: 50% of contributions up to 6% of salary.  Does your plan have a match?

2) It has a broad choice of low cost funds: Less expenses means more money at retirement for the participant, hence better outcomes.  A good way to tell if your plan has a broad choice of low cost funds is to find out if index mutual funds and exchange traded funds are in the line-up.  Does your plan offer index funds and exchange traded funds?

3) It has good service providers: The expenses in the plan that cover administration and investments should be buying you good service – from recordkeepers (on administrative and plan design matters) and from financial advisers (for participant education and advice).  Do you notice recordkeepers and financial advisers visiting the company on a regular basis to provide service? 

As the amount of years spent in retirement increases – along with healthcare and custodial care costs – retirement planning is an increasingly important task.

And making sure that you have a good 401k or 403b is a nice place to start.

 

 

Getting Your 401k Allocation Right

 

 

 

 

 

As an advisor to individual investors and 401k plan participants, I am often perplexed by the way participants approach their investment selection in their 401k or 403b plan.  Some participants will simply mirror what their HR director does, while certain studies have shown that employees tend to just “equally divide” contributions among choices.  So if there are 4 fund choices, 25% will end up in each and if there are 5 choices, 20% in each and so on.  The names that are given to 401k investment choices don’t help much and in fact tend to confuse matters:

Capital Builder?  World Growth?  Dynamic Flex 1vx?  Constellation?  Magellan?

What do those names mean?

A 401k participant needs to get through the noise and to the signal – (what’s most important) and in the context of  401k investment selection, it’s the overall asset allocation that matters most.  That is –  the % mix of Equities (Stocks), fixed income (Bonds) and cash.

A clean and strategic way to do that is by selecting a “manged” or “target date” fund which should reveal clearly what the asset allocation mix is.  If a participant wants to mix and match investment choices such as Mutual Funds or ETFs  to create their own portfolios – that’s fine - as long as they are aware of what the overall asset allocation is.  (An allocation of 74% stocks will perform dramatically different than 38% stocks but it might be hard to know where you are by simply selecting funds with generic fund named after stars and cruise ships that were designed for marketing purposes, not transparency)

You can figure out – and continually monitor – your overall 401k allocation with assistance from your 401k financial advisor and/or the use of a software program from Morningstar or something similar.

 

3 Strategies To Boost 401k Plan Participation

  

 

 

 

 

 

About 1/3 of eligible participants do not participate in their employer’s 401k plan. (Source: department of labor).  As defined contribution plans continue to replace defined benefit pensions, increased participation benefits both employer and participant – so here are three strategies to help boost 401k participation:

1) Auto Enrollment:  In the great book “Save more tomorrow” the author points out that of all the methods that can boost participation – nothing compares with auto – enrollment.  The author draws a comparison between organ donations and 401k participation by pointing out  that countries who automatically have their citizens become organ donors and require  them to “opt out”  have significantly greater participation due to “inertia” ..and the same holds true with participation in 401k plans.

2) Consistent face to face investment education and advice:  Employees need a financial advisor to meet with participants regularly, not just at the initial enrollment meeting.  Plans that have an advisor who visits in person on a regular basis blow away the participation rate of those that do webinars – or even worse have no financial advisor at all.

3) Adequate and cost effective investment lineup:  A broad array of mutual funds and ETFs will encourage better participation.  But not too many choices; somewhere around 9-12 stand alone choices along with a menu of target date (Managed) funds is ideal.  Also – keeping the fees down with index funds and ETFs (and letting clients know the fees are reasonable) will help because a lot of bad press about excessive 401k fees may keep people away from the plan.

Increased 401k participation is a WIN – WIN - WIN for employer, employee and advisors – so consider the impact that auto enroll, face to face advice and a great investment lineup might have.

 

 

 

 

 

 

 

In the end, successful investing is less about being brilliant or shrewd and more about avoiding big (Dumb) mistakes.  Here are 3 of them made by 401k and 403b participants you should try to avoid:

1) Not deferring enough salary :  The most important aspect of your retirement planning is investing an appropriate amount during accumulation phase and withdrawing an appropriate amount at distribution time.  So a big (Dumb) mistake would be not deferring (investing) enough.  401k experts recommend that you defer 12.3% of your salary (Source:  save more tomorrow, page 98, Shlomo Benarzti)

2) Trying to time the market:  Certain systems are too complex to predict what will happen in the near future.  What makes market timing so hard is that you need to be right twice:  at the top and again at the bottom.  You’re better off setting a strategic asset allocation based on your goals and objectives and re-balancing occasionally.

3) Under diversification:  Some investors mistake “familiar” with “safe”.  Because they are familiar with the brand of their employer they assume the stock is safe and end up with too much company stock in their 401k or 404b plan.  But anything can happen to one company (Think Enron, Lehman, Pan Am) so it important to properly diversify.  If more than 10% of your account is in any one company you are under diversified.

To be a successful participant investor in a 401k/403b plan you don’t need to be Warren Buffett or George Soros.  Just avoid the Big Mistakes.. starting with not deferring enough, trying to time the market and being under diversified.

4 trends in 401k and 403b plans…

 

 

 

 

 

 

If you are 65 years old, in good health and married, there is close to a 50% chance that you or your spouse will make it to 95 (source financeware.com)

Further, there will be less and less reliance on Corporate benefits and government entitlements for retirement income security.

All of this is resulting in a shift (back) to fiscal self-reliance in retirement and – for better or worse – the 401k and 403b plan will continue to play a big role in this phenomena.

With that in mind, if you are an employer (sponsor) of a 401k or 403b plan here are 4 trends you want to know about:

1) Expense management: The new fee disclosure rules are finally having an effect – fees are coming down to earth where they should be.  According to a recent survey by NEPC, LLC  “Fees related to retirement investment accounts hit a record low this year.  In particular, recordkeeping costs, the second largest component of total fees, saw the sharpest decline”.  You can now get a  very good 401k plan for an “all in” fee of 1% or less.  1.5% may be reasonable depending on the plan size and services being rendered.  2% is now excessive.  Make sure to peel back all the layers of the plan – administration, recordkeeping, investments, etc. to shed light on the true cost – as the companies tend to make that difficult to see.

2) Roth Features The roth option was intended to expire on December 31st 2010 – but the Pension protection act extended the Roth Option indefinitely.  Adding this feature is  a no-brainer.  The Roth feature allows participants to contribute after tax dollars then enjoy tax free withdrawals at retirement.  While many will pass on it looking for the current deduction – some folks will go for it – so it’s definitely an option participants should now have.

3) “Auto arrangements” The jury is out and the verdict is in.  Auto features work!  The only thing harder than making a decision is changing one – and there lies the magic in auto features.  The great book on 401k plans Save More Tomorrow informs us that nothing comes even close to auto enrollment (and its sister feature auto escalation) in  improving retirement outcomes.

4) Fiduciary services: (This is not intended to be legal advice, just an overview) As you evaluate a new 401k plan (or re-evaluate your existing plan) understand that there are differing levels of fiduciary Protections to consider from partial to total responsibility including:

  • ERISA Section 3(21):  These advisers assume “co – fiduciary” responsibility.  They can offer objective advice to the plan sponsor who then makes the final decision on investments options
  • ERISA section 3(38):  This flavor of advisor assumes “total” responsibility – and liability – for selection monitoring and removal of investment options
  • ERISA 3(16):  These folks assume total responsibility for the administration and operation of the entire plan, including hiring and firing service providers, timely filings, disclosure notices and more.
 
As we take control of our retirement security by creating a sufficient income that cannot be outlived – we need to keep up with trends in 401k and 403b plans – and expense managements, Roth features, auto arrangements and fiduciary services are some of the newer and very important ones.

 

 

 

 

 

 

 

 

Since January 1 2006, employers offering 401k retirement plans to their employees have been able to amend their plans to accept contributions on an after-tax basis, similar to Roth Individual Retirement Accounts (Roth IRAs).

Designated Roth contributions grow with tax-free earnings and are distributed at retirement without triggering any future income tax liability.  Although the Roth 401k option was intended to expire on December 31, 2010, the Pension Protection Act of 2006 extended the program indefinitely. Here are some things to consider:

BENEFITS FOR EMPLOYEE-PARTICIPANTS

The Roth 401k combines elements of both a Roth IRA and a traditional 401k plan.  The Roth 401k:

  • Does not limit participation by income, unlike the Roth IRA
  • Allows participants to contribute on an after-tax basis, like the Roth IRA, up to the amounts permitted under a traditional 401k.

Therefore, higher income employees who are ineligible to open a Roth IRA can instead contribute to a Roth 401k at higher amounts than are permitted in a Roth IRA.   By contributing to a Roth 401k plan, employees can contribute on an after-tax basis without being taxed in the future.

ROTH 401K REQUIREMENTS

For an employer to offer a valid Roth 401k plan:

  • The employer must also offer a traditional 401k plan.  Designated Roth accounts cannot exist without an accompanying pre-tax elective deferral plan
  • Participants must be able to designate some or all of their elective deferrals as Roth 401k contributions
  • The employer must include designated Roth contributions in the employee’s gross income (IRC 402A(a)(1))
  • Roth contributions must be tracked and their records kept in a separate account, with any applicable earnings and losses allocated to that Roth account

EMPLOYER CONTRIBUTIONS

Employers may not make contributions to a designated Roth account.  Any employer contributions, such as matching or profit-sharing contributions, must be treated as pre-tax contributions and added to the participant’s pre-tax account.  (However, special rules apply for in-plan rollovers to a Roth accounts)

DISTRIBUTIONS FROM ROTH 401K ACCOUNTS

As with a traditional 401k plan, participants may only receive distributions from their Roth 401k accounts on (if permitted under the plan’s terms):

  • Terminating employment
  • Death
  • Disability
  • Reaching age 59 1/2
  • Determination of hardship

In addition, unlike the Roth IRA, Roth 401k plans are subject to the IRC’s minimum required distributions requirements during the participant’s lifetime

 

ADDITIONAL CONSIDERATIONS FOR ROTH 401K PLANS

Employers may choose to offer the following optional features in Roth 401k plans:

  • Automatic enrollment
  • Employer matching to the accompanying pre-tax account.
  • In-plan rollovers
  • Plan loans.  All of the participant’s Roth and non-Roth accounts are combined when applying plan loan rules

So, who should consider taking advantage of the new Roth in-plan conversion rule?  Here are a few of the most compelling examples:

  • Young savers:  If you are just starting out in your career, you are likely in a lower tax bracket and have a smaller account balance.  Converting some or all of your existing pretax account will set you up for more than 40 years of tax-free compounding.  Just make sure that the move does not bump you into a higher tax bracket.
  •  Someone saving for somebody else:  Assets in a Roth account are bequeathed income-tax free to a spouse or the next generation.  This right allows the recipient to extend the tax-free compounding for many more years.
  •  Someone with a lot of deductions or a large loss:  If you find yourself with a large tax deduction such as a business loss, charitable contributions, or even medical expenses, the taxable income generated by an in-plan Roth conversion is a creative way to fully utilize some or all of these deductions.  A sudden drop in your 401k account value (think 2008) might also present a window of opportunity to convert to a Roth, pay taxes on a greatly reduced amount, and then withdraw the resulting rebound tax-free years later.
  •  Someone concerned about being in a higher tax bracket in retirement:  Many American workers today find themselves in a historically low tax bracket.  So paying taxes on your retirement savings at today’s low rate hedges the possibility of higher tax rates in the future.
  •  Action steps:  First, while Roth in-plan conversions are part of the new IRS rules for retirement plans, they are not automatically available to everyone.  Your employer must amend its plan to allow for them.  If you’re interested in taking advantage of a Roth in-plan conversion, step one is to ask your employer if they have taken the necessary steps to make them available.

While it’s critical to spend the requisite time making sure that you’re saving enough and properly invested for retirement, the tax efficiency of your retirement investment strategy deserves some attention as well because it can have a profound impact on your ability to retire comfortably.  Hence used properly, a Roth in-plan conversion is a powerful new tool that can help you achieve your goal of financial security in retirement.

 

 

 

 

 

 

 

On June 11th, I participated in a webinar titled “DOL Consolidates Its Strengths In Revolutionizing ERISA plan Enforcement” arranged by Fiduciary Doctors LLC and the Valley of the Sun United Way – with distinguished guest Mary Rosen, Associate Regional Director of the Boston Regional Office Of the United States Department Of Labor. (DOL)

As my area of competence is financial planning and investment advice, not 401k compliance, I took a lot of notes.  Here are the highlights:

  • The definition of a 401k plan fiduciary is based on what Ms. Rosen called  “Discretion of control”. That is - someone with any control over the investments and/or administration of the plan.  Another way to consider who is a fiduciary is anyone who “touches the plan in any way:  payroll coordinator, HR executive, investment committee, member et cetera.
  • VC letter stands for “Voluntary Compliance letter”; essentially a way to come forward if your 401k plan has been out of compliance – rather than waiting until it’s discovered.  It seems analogous to a child telling his parents about something that happened in school before the school calls them – and it lessens the fines/penalties.
  • The DOL apparently does their own criminal as well as civil investigations.
  • There has been over one billion dollars of civil enforcement pertaining to 401k and other benefit plans including:  assets restored, protected and correcting prohibited transactions et cetera.

Regarding 401k plans, there are steps that plan sponsors can take to “minimize bad outcomes” according to Ms. Rosen:

  1. Make sure you discharge your fiduciary duties in an acceptable way.
  2. READ your plan document and understand what it says.
  3. Understand your roles with the plan and what is required from ERISA (To act prudently, solely in the best interests of plan participants and pay reasonable fees to name a few).
  4. If you don’t have expertise in a particular area you can delegate – BUT delegation is also a fiduciary act so it needs to be done prudently.
  5. Documentation goes a long way if there is an investigation so document as much a possible.
  6. Regarding disclosures – 408(b)(2) AND 404(a)(5) a 401k plan sponsor needs to understand the information received – if they don’t they should question the provider or consult with an advisor.
  7. Provide investments with reasonable fees – if investments have high fees with no alternatives the 401k plan sponsor could be liable.

The call closed with the moderator asking about a change in the definition of a fiduciary for plan advisers – Ms. Rosen said it’s still a work in progress but couldn’t be specific.  So keep an eye out for that…all in all a useful call with helpful information for a financial advisor or employer who sponsors 401k or other qualified retirement plan.

 

 

  

 

 

 

 

 

 

 

Recently, I took on the fiduciary duty and liability of selecting and monitoring the investment lineup for a 401k retirement plan acting as a 3(38) “defined manager”.  

Selecting the equity and fixed income choices was manageable:  made sure I hit all the Morningstar style boxes; large, mid, small – US companies, foreign, fixed income, et cetera.  Kept costs down by choosing mostly index products, carefully and selectively adding some actively managed funds and featuring a robust choice of “target date” managed funds.  So far so good:  But where it started to get sticky was when it came to the “safe choice”.  Do we go with a stable value fund or a traditional money market??

Turns out I ended up going thru  a long maze of research which included:  phone calls with experienced and well informed Stable value providers, a host of Google searches and web sites – as well as a conversation thread on two LinkedIn groups – (The 401k Association and The Fiduciary Society For Ethical Financial Practices)

So what did I learn?  I learned there are basically two “camps” or “schools of thought” when it comes to the proper safe choice investment in a 401k plan;

One camp is convinced that stable value is the way to go – in fact a recent article suggests that if stable value is NOT the safe choice it should be a fiduciary breach!  This camp points out that the returns of stable value are considerably higher than money market fund.  Certain research also suggests that stable value returns have enjoyed higher returns than money markets for a very long period of time.  So if you can offer participants higher returns with the same – or arguably less – risk, why not?

Not so fast argues the other camp;  pointing out restrictions, penalties and incipient costs. One LinkedIn commenter suggested they are as “dumb as annuities” and a “throw back to group accounting”.  

Also is a “better” safe option really in the best interest of plan participants?  Should advisors be touting a stable value fund because it earns 1.0% or  1.5% instead of 0.1%?  Is that fear mongering that will scare participants away from what most of them really need:  a long-term growth oriented portfolio?

Other naysayers of stable value point to the benchmarking and fee negotiation – as the underlying insurance contracts in stable value funds force a group annuity structure exempt from fee disclosure.  Further, the record keeper is often the manufacturer of these insurance contracts making them severely conflicted.  These flaws, some suggest,  fly directly on the face of fee disclosure which is the core of the stable value problem – not an issue of retirement readiness.

If you are a fiduciary, advisor or a sponsor of a 401k retirement plan, have you looked at this issue? What are your thoughts about Stable Value or Money Market as your 401k Safe Choice?

 

 

 

 

 

 

 

 

We are constantly hearing  about the  ”Do’s” and Don’ts” in life.  As someone who can’t seem to get enough information; reading every book, magazine or web site I can get my hands on, I always seem to come across  Do’s and Don’ts:  DO eat right and exercise DON’T drink or smoke.  DO speak kindly to your spouse  DON’T text while driving, et cetera..

And while I can’t say I obey all of these all the time, I DO have a few them to share with 401k Retirement Plan Sponsors (Companies that offer 401k retirement plans)

DO:  Make sure you have an effective Investment Policy Statement (IPS) An IPS is a non-legal document that reflects the overall objectives and guidelines of your 401k plan and opens a channel of communication between the 401k advisor and 401k plan sponsor so important issues for either party can be clarified.  It’s one thing to say something, it’s another to put it in writing.  An IPS accomplishes the latter.

DON’T:  Assume you are not a fiduciary:  This sure is a timely topic huh?.  If you are using an insurance based or broker sold 401k plan you may have literature or other marketing material that gives the appearance that the provider is assuming fiduciary liability.  It’s not the case:  Unless you have contractually delegated the fiduciary duty of selecting and monitoring investments to a registered investment advisor via a 3(38) agreement - if you are involved in the plan decision making in any way – you are a fiduciary and can be liable for wrong doing.  You can also delegate administrative duties to a first party administrator serving as a 3(16) fiduciary.

DO:  Offer consistent and robust education (Face to Face) Living the information age, it’s easy to mistake information for wisdom or guidance.  There are a plethora of on-line 401k education tools but in the end – nothing beats face to face advice.  Especially when market drops are sudden and severe – and investment decisions are made viscerally – participants need proper perspective and sometimes a message of faith.  And you just can’t get those from a screen or tablet – only from an empathetic and trustworthy human being in person.  Further – numerous studies confirm that enrollment & education that is conducted face to face yields much better results than webex, webinar, face time, skype or anything else like that.

DON’T:  Have an expensive fund lineup:  A penny saved is a penny earned.  And lower fund expenses means more earned for participants.  I’m not saying to automatically go for the lowest cost plan / investments / adviser / record-keeper.  But make sure you peel away all the layers of the plan and understand exactly what the fees are and what services are being provided for them.  In today’s world you can get a top-notch plan with top-notch service for about 1% of fees “All in”.  So if your 401k plan’s fees are higher – you probably should shop it.

So Don’t exercise if you really don’t want to – But if you run a 401k plan Do have an IPS and face to face meetings but please Don’t assume you are not a fiduciary or have expensive funds.

 

 

 

 

 

 

It used to be pretty simple:  Graduate college, get a good job, work at the same company until age 65.  Then came the retirement party:  A gold-plated wristwatch – and banishing off to a condominium in the sun for a handful of years of shuffleboard and bingo.  Like the movie On Golden Pond.

But as the boomer generation continues its migration to and through retirement, the whole “concept” of retirement seems to be changing – at least for some.  Many of today’s retirees want to stay more engaged than those of previous generations:  working full or part-time, volunteering, travelling, learning, et cetera.  This is a good thing… I have noticed my own parents change for the worse… not long after they stopped working to enjoy full “retirement”.  Staying engaged after retirement is a good thing… as long as we have enough financial resources to last our lifetime!

In fact recent research from AIG and Sun America revealed that today’s retirees are dividing into about 4 (four) categories:

19% of retirees:  “Comfortably content”

These are the “Golden Years” folks.  Many in age segregated communities in warm weather climates.  Free from most responsibilities, looking to enjoy the fruits of their labor and they are financially secure.

22% of retirees:  “Live for today”

More active than Comfortably content; interested in more travel, new hobbies and “adventure” in retirement BUT modest net worth hence very worried and anxious about finances.

33% of retirees:  “Sick and tired”

Living a retirement “nightmare”.  Low net worth, poor health and pessimistic about the future.

27% of retirees:  “Ageless explorer”

Youthful, optimistic and adventurous.  Say they will never “feel” old.  High net worth as a result of making smart financial decisions.  They are sort of like the “live for today” group but with greater financial security.

Most people probably want to be in the “Ageless explorer” category.  And along with some good luck and a little health - sufficient financial resources will pave the way for this new kind of retirement.

And in the  25 years I’ve been rendering financial advice, I have yet to find anything more effective than dollar cost averaging –  over a very long period of time – into a 401K or Retirement portfolio comprised mostly of equities and a little fixed income.  It’s a boring and simple approach but it works better than anything I have seen.  The “get rich slowly” approach.  

Please share any other ideas you may have about how to financially prepare for a longer retirement!