For most people the 401(k) plan is their main, and sometimes only source of retirement savings. We know that if we can’t max out our contributions we should at least be contributing enough to receive the full match from our employer, but we really don’t know what constitutes a “good” 401(k) plan.
Every year the major financial news sites publish the same articles about this years “best” 401(k) plans, and every year I take major issue with the results in those articles.
Too often the studies that these articles reference weigh criteria such as the average account balance per participant too heavily. The same goes for judging the generosity of an employer by looking at the average amount they contributed to each employee in the plan. Of course you’re going to tell me Goldman Sachs has a better 401(k) plan than Wal-Mart if that’s how you’re judging it!
Metrics like these tend to sway the results in favor of companies whose employees make a lot of money on average, as you can see when you take a look at the top 401(k) plans according to this year’s list. It includes a bunch of medical and law practices and even a few professional sports leagues!
So what metrics should matter when judging a 401(k) plan?
Instead of judging the generosity of an employer by looking at the dollar amounts they matched in their 401(k) plans, we should look at the percentage they match.
A company matching up to 6% of your salary is obviously better than one that will match up to 3%. Likewise, the rate at which an employer matches should be considered. Company “A” and Company “B” can both match 3% of your salary, but if Company “A” matches at 50 cents per dollar, and Company “B” matches dollar for dollar, Company “B” should get the edge because you have to contribute half as much to receive the full match. (Related: Should I Contribute to a 401(k) With No Match?)
Variety Of Investment Options
401(k) plans are notorious for having very limited investment choices. My 401(k) plan offers 12 funds to choose from, my previous employer offered more than 20, my fiance’s plan only offers 8 funds in their plan!
Without a good variety of funds to choose from you might not be able to properly diversify your investments, or you may even be forced to default to a simple target date fund. That’s not a problem for some, but I believe the more control you can have over your investment choices the better off you are.
While a variety of funds is nice, not all funds are created equally. What we really want to see is a variety of low-cost funds. 401(k) fees can literally take years away from your retirement income. Between funds with high expense ratios, and with transaction, maintenance and other “hidden” fees that your plan administrator charges, your nest egg is being nickel and dimed at every turn in a lot of 401(k) plans.
The current administration has taken some steps to force 401(k) administrators to be more transparent about the fees they charge, but for the most part it’s still hard to determine everything they charge. The best we can do now is run our 401(k)’s through Personal Capital’s “401(k) Fee Analyzer”. It’s a great tool that will show how man years of your retirement you’re losing to investing in funds that are charging you high fees. After looking at your results you’ll be able to make smarter investment decisions within your 401(k) and keep more of your hard-earned money.
To be vested in your 401(k) plan means that you own all of the money that’s in there. Often times employers will set time limits on the length of time you have to be with the company in order to “own” the company match portion of your 401(k). This shouldn’t matter too much unless you end up leaving the company before you become fully vested. Then it could cost you thousands of dollars by having to forfeit all or part of your company’s contributions to the plan.
The point at which you become fully vested in your 401(k) plan is an often overlooked point in the quality of a plan. I’ve worked for employers where you were fully vested from your first day on the job, and for others where you had to wait 3 years before being fully vested. Obviously with the limited security that any one job provides, the sooner you are fully vested, the better.
Automatic Enrollment & Escalation
Let’s face it. Most people don’t have the handle on their money that you loyal First Million is the Hardest readers do. So a quality I think all good 401(k) plans should have is that they automatically enroll employees into the plan.
While most plans that do this only contribute 1% or so automatically, that could be 1% more than that employee would contribute otherwise. Something is better than nothing!
Another good feature for 401(k) plans to have is an automatic escalation feature. This feature automatically increases your contribution amount by 1% each year until you reach either a set limit, or the contribution maximum. By increasing contributions gradually and by a small amount you almost don’t realize you’re contributing more than you used to, yet it has a massive effect on your account balance.
While I believe those are the most important features to look at in determining what separates a good plan from a bad plan, there are many other features that 401(k) plans offer that you may find useful.
Some plans allow you to split your contribution between a traditional 401(k) and a post-tax Roth 401(k). (Read: Should I Contribute to a Roth 401(k)) Others offer free consultations with a financial advisor who will review your investment choices and offer guidance. Be careful though, often the advisor may try to steer you into unnecessary funds with high expense ratios.
Regardless of whether you have a great 401(k) plan or a terrible one, it’s probably still beneficial to contribute to it. Even the worst 401(k) plans still allow us to lower our taxable income by $17,500, which to some, may be the greatest feature of them all!
Readers: What are the best things about your 401(k) plan? What features do you think 401(k) plans should offer that they currently don’t?