Written by Alex Seleznev, MBA, CFP®, CFA | Sept 4, 2024
For many people, including our clients, their 401(k),403(b), TSP, or similar retirement plan at work will be one of the largest investment accounts.
Naturally, you would want to properly manage your funds in this account. For those who prefer to stay on top of their finances, it would also be helpful to understand how good your 401(k) account is.
After all, not every retirement plan is created equal.
My goal in this newsletter is to highlight some features you should be aware of, as they can impact both your short- and long-term decisions.
Fund Choices
Most modern 401(k) plans offer anywhere between 10 to 30 investment options, predominantly mutual funds.
If your plan offers choices from multiple providers such as Vanguard, American Funds, PIMCO, etc., chances are this is a good plan.
Watch out for plans that limit the investment options to their own funds only. This is not always bad but warrants caution.
For example, many 401(k) plans I’ve seen at Principal Financial consist almost entirely of their own funds. Principal funds are not considered to be the best-rated based on their performance and fees, which may put you at a disadvantage in a plan like this.
For most investors, my recommendation is to build a portfolio that matches your specific growth goal and overall financial plan.
If your plan comes with a limited number of good funds, you would want to complement them by investing in other options in your brokerage and/or IRA accounts.
For example, if your plan comes with well-performing large-cap funds and poorly performing (or higher-cost) small-cap funds, you would want to buy small-cap funds elsewhere (assuming you need them in your portfolio).
Talking about expenses…
Fund and Plan Fees
Even in 2024, it is still relatively challenging to figure out how much you, the plan participant, pay in 401(k) fees.
There are fund fees, in percentages, that are usually published on the fund’s summary page. A good plan will have many fund options with internal expenses of less than 0.50%.
Even today, I’ve seen some smaller 401(k) plans that offer funds with expenses of over 1.00% per fund. Generally speaking, you would want to stay away from funds like this.
Calculating your plan fees is a bit more challenging. But first, why would you care? Well, this would help you determine how quickly you should rollover your funds somewhere else if you terminate your employment or retire.
The plan fees are usually reported on the quarterly reports or under the “Plan Fees” section on the plan’s website.
I’ve recently reviewed a 401(k) plan for one of our clients at Voya Financial. They charge internal fees of 0.75% per participant. It turned out to be over $3,200/year for my client in addition to the fund fees. Rather steep if you ask me, given the generic service they offer…
Additional Plan Features
Most plans will offer a Roth (post-tax) contribution option and the ability to borrow up to $50,000 or 50% of the account value. As a side note, I rarely recommend borrowing from your 401(k) account unless we are dealing with a true emergency.
Some of the more advanced plans will allow you to implement the Mega Backdoor Roth strategy. Under this approach, you may be able to save up to $69,000/year in your 401(k) in 2024 ($76,500 for those over 50)
Relatively few plans I know offer a “brokerage window” that allows you to invest in funds and stocks outside of the general selection offered by your employer. This can be a valuable option for more sophisticated investors.
Please be wary of the retirement calculators offered on the 401(k) website. Even though they are simple to use, the results can be dramatically different from reality.
Here are some of the most frequently asked questions in our client meetings:
Should you invest in the Target Date Funds in your 401(k) account?
In most cases, my answer to this question is negative. Most plans offer at least a handful of options that would allow you to easily customize the investment mix for your specific needs.
Target Date funds are usually appropriate for first-time savers, small account balances, or in cases when no other high-quality investment options are available in the plan.
I have multiple 401(k)/403(b) accounts from previous employers. Should I consolidate?
Most likely. There are relatively few benefits to keeping multiple 401(k) accounts at this point. I would just make sure that your current 401(k) account is good.
My plan comes with limited investment options, high fees, but my employer matches my contributions. Should I invest in such a plan?
Most likely. Even when you account for the high fees charged by some plans, it still makes sense to contribute when your employer offers the match.
You just need to be more thoughtful in terms of the fund selections you make to come up with the best possible investment mix for your circumstances.
What does all of this mean to you?
I believe people should spend more time asking questions and understanding their 401(k) plans and options. Since it will likely be one of the largest investment accounts for you, you want to make sure the funds are invested prudently and reviewed periodically.
Once you leave your employer or retire, understanding how good your 401(k) plan is will make it easier for you to make the right decision about transferring the funds somewhere else.