If you are counting on your 401k plan for retirement - beware! The current financial crisis and stock market collapse are troubling enough, but what many retirement savers don't know is that their 401k plans may not be up to the task.
401k's have become the predominant retirement funding tool in the U.S. Twenty-five years ago. traditional defined benefit pensions were the primary type of retirement plan covering more than 60% of the workforce that had pension plan coverage. Today, defined contribution plans (mostly 401k) are the primary retirement plan for 63% of the covered workforce. Only about 17% of the covered workforce remains in traditional pension programs.
For the worker, this has meant a seismic shift in responsibility: where once the employer was responsible for seeing that workers contributed to the pension and that pension investments performed well enough to provide promised benefits, in the DC world, 401k planning responsibilities fall on squarely the worker. The best 401k plan sponsors provide generous matches, strong retirement/investment education support and other plan features to help out. Workers who take full advantage of these plans stand a good chance of accumulating adequate retirement savings.
But for many others, their 401k is a minimal retirement plan that offers only a weak chance of providing a decent stream of income to workers when they retire.
How do you know how your 401k plan compares? Here are five benchmark questions to guide you.
Does Your 401k Have an Employer Match? Employers are not required to match employee contributions. But the best 401k plans do match. Employer matching features are key to assessing the quality of a 401k plan. It is much more difficult for workers to accumulate adequate retirement savings with a 401k plan that lacks an employer match. For example, a 30 year-old earning ,000, contributing 8% (with a 50% employer match-up to 6%) and earning an 8% annual return will have 38% more in retirement savings at age 65 than the same employee with no employer match.
What is the level of your 401k plan's employer match? The most common matching level, according to Hewitt Associates, is Body.50 employer for each .00 employee contribution, up to a maximum of 6% of pay. Think of the employer match as an immediate, risk-free return on your investment (ROI). Regardless of the level of your plan's match, you should always contribute enough to get the maximum possible match. The higher the maximum employer matching contribution, the greater the opportunity you have to leverage contributions and build a retirement nest egg. According to the Profit Sharing/401k Council of America, the average employer match is 3%. Less than 5% of plans match more than 6% of compensation.
Does your 401k investment menu include low-cost, broad-market index funds for stocks, bonds and international investments options from one or more large and reputable mutual fund firms (e.g. Vanguard, Fidelity, Charles Schwab, T. Rowe Price, etc.). Prudent investing in index funds is almost always the most cost-effective long-term strategy for 401k participants. Large, well-run index funds from reputable mutual fund firms have very low expenses so that the money you and your employer contribute goes to work for your retirement instead of going to pay fees and costs associated with so-called "actively managed" funds. Mounds of academic research show that over the long-run, index funds outperform actively managed funds. If your 401k plan doesn't offer quality index fund options, it is a serious shortcoming.
Do any of the investment options under your plan include sales charges (such as front or backend loads, deferred sales charges or redemption fees)? There are plenty of excellent no-load funds available in every category of investments. If you plan includes investment funds with sales charges or loads, you're likely paying that are higher than they should be.
Check if your plan automatically enrolls new employees in the 401k plan (unless they specifically opt not to enroll)? Automatic enrollment is a relatively new 401k feature intended to increase 401k participation particularly among younger workers and other groups who may not recognize the importance of retirement savings. Research shows that for participants with incomes under ,000, 401k participation increases from 44% to 86% with automatic enrollment. For participants age 25-34, participation increases from 56% to 86%. Presence of an automatic enrollment feature is a good indicator that your employer is serious about helping workers save for retirement.
There are, of course, many other questions and issues that can be raised with regard to the overall quality of a 401k plan. These five questions are a basic guide. For a more thorough assessment, you can use this 401k plan assessment tool. Don't be afraid to ask your company's human resource department for help in getting answers. It is your future retirement at stake and letting the company know the quality of the 401k plan is a priority is a message worth sending.
