Even though 401(k) plans have become the defacto standard of retirement savings for most in the US, problems still remain with 401(k) plans that investors at all income and participation levels should be aware of.
At the time of this publishing many plans have lost a significant portion of their value for the first time in a decade, and similar to 2008 many employees are seriously contemplating what to do with their retirement investments.
Given that the rate of saving tends to decrease during a recession, the performance of 401(k) accounts and the ability of fund managers to be suitably defensive or responsive can become hindered as conditions change.
In the end knowledge is power, so the more you have the better position you are in to affect positive change on your retirement!
TRANSFERRING 401(K) EARNINGS
We no longer live in a world where people remain at one employer for 20 or 30 years. Switching jobs is much more common now and each switch could be another 401(k) plan.
Transferring your 401(k) plan to a new job can sometimes be problematic. Not only is there paperwork to be deciphered and filed, you'll also have to coordinate actions with your former employers.
It is always prudent to examine the financial climate and various options when you switch jobs to determine whether your funds would be better left where they are. Just because you no longer work for an employer does not mean your 401(k) needs to go too. The caveat is you cannot contribute to that plan anymore.
Switching does take time and effort on the part of an employee, many of whom are not accustomed to spending it on financial matters. That is of course, why so many people hire professionals to manage their investments.
If your 401(k) earnings aren't periodically transferred, you may eventually have several different plans left to various types of management. In such cases you may want to consider rolling your prior 401(k) plans into a single IRA and hire the help of a financial advisor to manage it.
Sometimes people decide to cash out an old 401(k) altogether, but that comes with a price. Taxes and a penalty for early withdrawal would then have to be paid, costing a decent chunk of money.
TRANSPARENCY ISSUES
If you have a 401(k) you likely get a quarterly account statement that lets you know how your account performed for that period.
More important though are the annual plan reports. Your plan administrator must file a Form 5500 each year and from that the summary annual report (SAR) is produced and sent to all plan participants.
This is where you can find the details of the plan for that year.
Here are the basics of what the SAR is required to disclose:
• Basic plan financial information
• Plan administrative expenses
• Value of plan assets
• Employer and employee contribution amounts
• Participant’s rights to information
• Funding standards and compliance
• Right to receive a copy of Form 5500
Knowing the information you have rights to is just plain prudent, especially if you want to ensure you are getting all the detail on fees you pay.
This is where the annual fee disclosure notice comes into play, which is made up of:
• Participant fee disclosure - Reports the plan and individual-level fees that might be deducted from participant accounts.
• Comparative chart – Reports certain plan investment information, including past performance, expense ratio, shareholder fees, and trade restrictions (if applicable).
Even with these disclosures, fees are not always communicated well to plan participants. Better yet, they are often “hidden” within something called expense ratios.
Keeping an eye on the amount of “hidden” fees being skimmed off the top of your 401(k) account can make a huge difference.
This next part is so important…
What really needs to be grasped here is the double whammy that paying extra fees really is. It is not just the fact that more fees are being taken from your account than needed. It is that those dollars would otherwise be in your account earning a return and growing.
So not only are you spending more dollars, you are also losing the potential growth on those dollars. That is what makes it a double whammy!
Believe me, it adds up big time and suddenly it goes from thousands of dollars to tens of thousands of dollars or more lost from your retirement account.
Let’s look at a simple example, say you have a…
• 401(k) with a $25,000 account value
• Contribute $5,000 a year to it
• 30 years till retirement
• Receive 10% annual returns (S&P 500 average return in common era)
• Pay 2% in total fees on your account
Come retirement you can expect to have $817,982 in your 401(k) account, which is nothing to sneeze at.
However, what happens using the same account parameters and reduce total fees by 1%? How much of a difference can that really make?
With fees at 1% the account value jumps nearly $200,000 to total $1,013,230.
Think about that, you can potentially add $200,000 to your retirement savings just by cutting fees 1% - that is mind blowing!
Let’s look at it another way using the same example from above.
Total Account Value at Retirement:
2% fees = $817,982 1% fees = $1,013,230
Difference = $195,248
$195,248/$1,013,230 = 19.25%
The account paying 2% is worth nearly 20% less. Do you want 20% of your retirement account going to someone else?
What is interesting - this example is conservative assuming a static $5,000 contribution each year. Earnings will likely increase throughout your working years and therefore your contribution will as well. This will only increase the impact of higher fees and lost retirement savings. $200,000 could easily turn into $300,000 or even half a million.
You may be wondering how the heck this math works. How can 1% add up to so much?
Well, you will find out in tomorrow's post: The Power of Compounding Interest.....