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Does your 401(k) plan need a makeover?

Employees are demanding that their companies offer stronger retirement plans. Here’s how you can, too.

Published: August 27, 2015 06:00 AM
Illustration: Sebastien Thibault

 Given how tough it can be for many people to save for retirement, it’s unfortunate that some companies make it even more difficult. But a large number of 401(k) plans do just that by imposing high costs and offering subpar investment choices.

The problem is more widespread than you may realize. Robert Hiltonsmith, a senior policy analyst at Demos, a public-policy group that has examined 401(k) plans, says that Americans pay $50 billion more than they should each year.

Consider the consequences of high costs. A study by the Center for American Progress, a think tank in Washington, D.C., found that if you invested in a retirement savings plan with costs of 1.3 percent annually (the average fee at companies with fewer than 100 employees), you’d end up paying almost $125,000 more than if you were in another plan with low-cost funds that had fees of just 0.25 percent.

Until recently, employees were stuck with whatever retirement savings plan their company offered. In the last few years, however, they have been fighting back, suing their employers for failing to monitor high costs, favoring more expensive retail mutual funds over less costly options, and funneling employee savings into investment products managed by affiliate companies.

And now, employees have the law on their side.

Earlier this year, in a lawsuit against Edison International, a company that operates electric utilities in Southern California, the Supreme Court unanimously ruled that because of the Employee Retirement Income Security Act, companies have a legal responsibility to continuously monitor investments in retirement savings plans and, if necessary, remove imprudent investments.

And last July, a similar lawsuit on behalf of employees and retirees at Lockheed Martin was settled out of court. There have been other cases against companies including Boeing, the Massachusetts Mutual Life Insurance Company, and Walmart.

How good is your company's 401(k) plan?

Tell us and other readers about your employer's offerings by adding a comment below.

 
 

So how can you tell whether your plan is a dud?

  • Look at the expenses of the fund. You can find them by logging in to your account online or looking at the prospectus for the funds you own. They may also be listed in your plans' statement. In addition, the administrator of your 401(k) plan is required to notify you annually about the costs you're incurring. If you see a number of funds with expense ratios (the annual cost of maintaining a mutual fund) of more than 0.76 percent, you probably have a high-fee plan, Hiltonsmith says.
  • Examine the funds provided by your plan. A large number of options isn't necessarily better. In fact, too many investment choices can be confusing and cause you to succumb to "analysis paralysis." A well-diversified 401(k) plan will include a selection of stock funds, including large-company and small-company funds; international funds; and perhaps a total bond fund. Instead of offering only actively managed funds, the plan should also include cheaper index funds. They hold stocks of companies in a specific index–say, the Standard & Poor's 500–and often have expense ratios of less than 0.2 percent, much less than comparable actively managed funds.
  • Check whether your plan offers target-date funds. Those mutual funds automatically reallocate the mix of stocks, bonds, and cash as you age. Their fees may be higher than index funds–0.78 percent, on average, according to Morningstar, the investment research company–but they're a good way to manage risk as retirement draws nearer. About 70 percent of retirement savings plans now include target-date funds.

Get a better plan

If your plan has expensive funds and falls short of good options, the solution may be to encourage your employer to improve it.  
  • Find the fiduciary. That person is your primary contact for all correspondence and is listed in the documents. Or you can ask your employee-benefits manager for the correct name and contact information. Or search for your company plan online at brightscope.com. The fiduciary’s name will be on your plan’s page under the tab for Form 5500 data. (That’s a federal disclosure form that must be filed for all retirement plans.)
  • Collect documents. Look up the fund expense ratios in the annual disclosure of your expenses. You’ll see in the report an explanation of each fund’s average annual returns over one, five, and 10 years; the comparable returns of a benchmark fund; and the average annual operating costs as a percentage of assets and as a dollar figure per $1,000 invested. You also should receive a quarterly fee statement showing additional expenses specific to you, including loan-administration fees.
  • Research new funds. Your plan may have a good variety of investment options but may not offer the least costly versions. Search for similar alternatives at such low-cost fund families as Vanguard or T. Rowe Price. Then compare the candidates with a comparable index fund at the website of the Financial Industry Regulatory Authority. You’ll need the comparison to see whether your choices are better investment options.
  • Present your argument. Write to the fiduciary with the details of your research. Emphasize how the costs affect not only you but every employee who invests in those plans. Ask co-workers to sign your letter. If a number of employees complain, the fiduciary is more likely to take the letter more seriously.
  • Consider alternatives. Even if the plan is crummy, if your company matches your contributions­—and most do, although the amounts vary widely—it may be worth staying to get the free money. Contribute the minimum amount—usually at least 3 percent of your salary—to take full advantage of the match. If the investment options are pricey and there’s no match, stash your savings in an individual retirement account, where you make your own investment choices. Just remember that you can contribute only $5,500 per year to an IRA—$6,500 if you’re 50 or older—compared with $18,000 in a 401(k).
  • Check your spouse’s plan. If it’s better than yours, consider maximizing contributions to it.

Leave it or roll it?

When you change from one job to another, should you move your 401(k) to your new employer’s plan or leave it where it is? That depends on how much you have invested in the plan and how it stacks up against the new one.


Leave it with your former employer. If it’s an excellent plan and your employer allows you to stay, there may be no need to move those savings. The lower costs of a well-managed plan will more than compensate for what are usually modest maintenance fees that may be assessed on the accounts of former employees.


Mingle the money with your new employer’s plan. Chances are that you’re changing jobs not just for better opportunities but also for better benefits. Some employers allow rollovers from a previous employer’s plan. Compare the plans to see which offers more choices and lower fees.


Roll the assets into an IRA. If neither plan has a good choice of investments and the fees seem high, consider rolling over your 401(k) savings into an individual retirement account. Keep in mind, though, that you may incur a different set of costs. For example, buying and selling investments will usually result in commissions, and there may be other fees charged by the custodian of the fund.


Don't cash out. The worst choice you can make is to withdraw from the 401(k) plan with your former employer and not roll the funds into a new plan or an IRA. After 60 days, the funds are taxable, and if you’re younger than 59½, possibly subject to tax penalties. In many states, taxes and penalties will claim almost half of the amount that’s withdrawn (known as an early distribution). By any measure, that’s a poor return on an investment.


Editor's Note:

This article also appeared in the October 2015 issue of Consumer Reports magazine.

 

 



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