Imperfect 401(k) Plans
Nov 6, 2019
Your 401(k) can be your most powerful retirement savings tool. But it’s not perfect. Let’s talk about some of the weaknesses that you should be aware of in your 401k (or 403b…or TSP…or 457).
Here are just a handful of the things that we'll discuss:
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Transcript
Mark Kilian: You're back here with us for another edition of Wright Money Tips with Isaac Wright. I'm your cohost this week. Mark Kilian siting in here on the podcast for John Stillman who is out and a little under the weather. And Isaac, welcome in and thanks for having me here this time.
Isaac Wright: Mark, don't make it sound like you and I have never talked. We do a lot of radio work together, so by no means are you a rookie at all of this. But yeah, doing good man. I'm obviously chugging along through the fall here as we get into the end of the year. I think we have some good topics lined up, but I think the topic today that we had, I know we talked a little bit about it before we jumped on the air today, but just some of the things that we see when it comes to 401ks and I think with that in mind, I think it'll be a good conversation.
Mark Kilian: Yeah, and definitely I've done the radio show with you a number of times, but haven't done the podcast with you. So pretty cool to be here in this format. And so I'm looking forward to that. But yeah, the 401k. So look, it's a great tool, right? I mean it's a very powerful retirement savings tool, but let's talk about the fact that it is not perfect. And Isaac, when we say 401k, let's just let everybody kind of in on the fact that we're ... Let's throw the whole alphabet soup in just to make it easier. Talking 403bs, TSPs, 457s, but when we say 401k, we're kind of referring to all of these kinds of vehicles. So let's just point out a couple of the weaknesses to be aware of like administrative costs there. They're not cheap.
Isaac Wright: Well, and dependent upon the company that's offering and the company that you work with that has a 401k or a thrift savings plan or 457 you know, these various forms of plans that you can get involved in saving for your retirement, which is, again, I want to be clear is a good thing. And a lot of them now have the option of being able to invest money in a quote traditional plan where it's growing tax deferred and some of them now offer the Roth option, which allows you to put money away. Pay the tax now and of course have that money in the future tax free, if you play by the rules of course.
Isaac Wright: But the underlying thing that I want to be clear about is when it comes to a 401k, and this is predominantly what I see is just some of the unknowns where people walk in, they're trying to make a decision, does it make sense to leave money in an employer plan? Does it make sense to roll over money into an IRA? And I just want to point out some consistent things that I see on 401k. Is that people sometimes don't always know. And so when we're talking number one about administrative cost, depending upon your employer, sometimes it's ... And whether you know this or not, it's not necessarily cheap for an employer to offer a plan on the 401k chassis sometimes.
Isaac Wright: So you normally have costs that sometimes and in the past it's never been sometimes disclosed, let's call it these underlying administrative costs can be passed onto you. Normally the smaller the company, the higher those costs are going to be for each person just because of scale and because you just don't have a situation where let's say, now and I think this is being changed on a lot of different plans. You may want to pay attention to this if you have a 401k. Is that they are doing a better job of disclosing fees. I would say that they're not all the way there yet, but administrative costs can absolutely be something that you need to pay attention to when it comes to the portfolio itself or the 401k itself.
Mark Kilian: Yeah, absolutely and again, scale of the size of the business kind of goes into that to some degree, but we'll keep on with a couple of just bullet points here about a few of the weaknesses you might find in the 401k. And some mutual funds. Let's just talk about those. You're going to find that there's just not a lot else. I mean, you might have, I don't know what 20 options or so maybe.
Isaac Wright: And sometimes not even that, but yeah, just the backup on a mutual fund. A lot of times when you have a 401k, you primarily have mutual funds as an option. Okay. You may have an option to buy company stock. You may have an option to maybe put money in a cash or money market or stable value fund, but a majority of the investments that you're going to choose to buy stocks and bonds typically come in the form of a mutual fund. And the limitations of those choices can be pretty apparent. So a lot of times 401ks will offer you different, let's call it options to participate in different asset classes within the stock market, but normally that's limited to stocks, bonds.
Isaac Wright: Number two is when you have, let's say the money in just those quote unquote mutual funds, it can make it difficult again, sometimes to know what those costs are. Those mutual funds have underlying portfolio fees, manager costs. It can vary quite dramatically, Mark, I think for all of you listening. You can have fund fees of a quarter to a half a percent all the way up to two to three percent a year. You may not be aware of that. Or of course when you get your 401k notice or the options you have, they've tried to be better about disclosing those fees as well. But just know that outside of a 401k you may have a very good option to be able to open up an IRA and have very low cost funds or ETFs or you can buy individual stocks and that's sometimes, in a lot of respect, when you leave or you separate service from your employer. That's a strong consideration of why you want to have money potentially rolled over to an IRA.
Isaac Wright: So just keep that in mind. You have administrative fees, you may have additional mutual fund fees and a limitation on the overall amount of mutual funds, or let's call it more importantly, investments that you can choose from.
Mark Kilian: Okay. And talking about that, we'll stay with that theme, Isaac for a minute. So when you're thinking about some mutual funds, a lot of times we'll see people who have ... They'll say, "Well, I'm diversified because I've got 7, 8, 9, 10, 12 however many mutual funds." And a lot of times it's just large cap and there's a lot of overlap with companies in there. So there are ... 401ks do have limited asset classes I guess is my point.
Isaac Wright: To be a little bit more fair to the 401k. Most 401ks when they give you the menu of options for the funds you can choose. So if you had these mutual funds, they'll give me an option for let's say a large cap fund, a mid cap fund, a small cap fund, maybe an international stock fund. These are all stock asset class options with inequities. So you have all of those options normally. But most plans don't really allow you to diversify into other asset classes. A lot of times you're going to just be able to own traditional stocks or stock funds and maybe traditional bond or bond funds. And have that stable value account. And again, you may have the chance to own your own company stock, which dependent upon that situation may or may not be the best thing for you. But just keep in mind you probably do not have, or if you do, you may have a very limited amount of selection towards the following.
Isaac Wright: You may want to invest some of your retirement in a commodity index or owning commodities outright or real estate or having money invested through a fund that invest in real estate. Or health care or energy. You may want to have sector plays and again, just to reiterate, you may only have the chance to buy your company stock as an individual stock selection. That's the only thing you may have an option for. So you have a limited amount of investment options. But also what we normally find is a limited amount of asset classes that you can also choose from.
Isaac Wright: So again, when you're running around working 40 plus hours a week or trying to volley multiple activities, sometimes you may not necessarily look at your 401k as often or when you do, these are things that may or may not hit you initially, but you need to be aware of them. Especially, as you get to the point where you have some flexibility of whether or not you want to leave money in a 401k or again, roll that money over into an individual retirement account. So these things, Mark, I know we talk about them quite often, but I thought this was a good thing to kind of cover some bullet points here. I know we've got one more today, but yeah, just crazy how 401ks you would think that they would expand those options.
Mark Kilian: Yeah, no, I agree with you. And I guess that was going to bring me to ... And I'm glad you mentioned the last point, but when we're talking about some of the weaknesses to look out for. So again, they're a powerful tool. They're great tools, we should definitely be using them, but as we're aging and we're getting closer to retirement, a lot of people start looking for more conservative investments. Maybe to take some risk off. And you may find the 401k a little lacking in that department. Yes?
Isaac Wright: Yeah, that's a good point. For people, again, normally you are eligible to move money out of a 401k depending upon your plan document through your employer. Under two main circumstances. One is if you separate from service, so when you leave your employer, you normally can take your 401k and have that money rollover to another qualified plan without having to take a taxes into consideration.
Isaac Wright: Number two is if you are 59 and a half, so you may still be working, but if you're over 59 and a half, a lot of plans have the ability for you to take what's called an inservice amount of money and roll that over as well. Sometimes people don't recognize or know that, but as you get older, so let's say you are 59 and a half or older. You may decide, especially on the nice run we've had in the market for many years in a row that you want to start, let's call it having some money invested in a fashion where you can keep it a little bit more conservative. To where you don't have to worry about a stock market crash ruining 25, 30 plus years of saving.
Isaac Wright: So in your conservative investment options in your 401k, you may have a maybe a bond fund, depending on the type of bond fund, it could be still pretty volatile, but normally you only other have, and sometimes even 401ks don't even offer this, but a stable value or money market fund. Now, if you've been paying attention to interest rates here as of late, they're starting to move back into a direction that literally is paying little to no interest. And all of us as we have saved money, want to be able to have what I call that money work for us constructively, which means is collecting money dividends. Income distributions off of that money that you save for retirement to live on. That again may be a problem if it's in the 401k and you don't have but maybe one or two options.
Isaac Wright: So having a multitude of more conservative based options. Again, diversifying that money also can help lower the overall risk of your portfolio that's earmarked for your retirement lifestyle. These are all things that we do at our firm more than you want to shake a stick at. I mean, so even though I know we do a podcast, our firm right here in Richmond, Virginia. Financial Dynamics and Associates does allow you to have what I call some clarity around does it make sense to make some of these decisions? And if you have any concerns, questions, again reach out. You can give us a call at (804) 777-9999. You can reach out or you can just go to wrightmoneytips.com and it'll forward you over to our site.
Isaac Wright: So Mark, as we wrap up here, I like what you just said, 401ks, great tool, gives you options. Especially if you have a Roth option in your retirement plan.
Mark Kilian: Mm-hmm (affirmative)
Isaac Wright: But in the construct of how to invest your money, we can help you if you are in a position where you don't have the ability to roll over money in a 401k. How to help at least balance and let's say properly manage that out for you as you start moving closer to retirement. For those of you here that are already 59 and a half are separated from an old employer, I hope this has been helpful. Definitely want to pay attention to what I've covered and reach out if we can help in any way. So Mark, with that being said, man, I think that covers it all today.
Mark Kilian: I think so too. Thanks for your time here on the podcast. Good information around the 401ks. Again, a great tool. They just have a few weaknesses to be aware of, and of course Isaac as he mentioned, reach out to him. Great thing about a podcast too is you can always rewind and listen to parts of it again or reach out to him a couple of ways, as he mentioned, (804) 777-9999, or go to wrightmoneytips.com. This has been another edition of the Wright Money Tips Podcast with Isaac Wright and we'll see you next time right here on the program. Thanks.
Announcer: Information is for illustrative purposes only and does not constitute tax investment or legal advice. Always consult with a qualified investment, legal or tax professional before taking any action.
Announcer: Advisory services offered through JW Cole Advisors Inc, JWCA. Financial Dynamics and Associates Inc. and JWCA are unaffiliated entities.
Isaac Wright: Mark, don't make it sound like you and I have never talked. We do a lot of radio work together, so by no means are you a rookie at all of this. But yeah, doing good man. I'm obviously chugging along through the fall here as we get into the end of the year. I think we have some good topics lined up, but I think the topic today that we had, I know we talked a little bit about it before we jumped on the air today, but just some of the things that we see when it comes to 401ks and I think with that in mind, I think it'll be a good conversation.
Mark Kilian: Yeah, and definitely I've done the radio show with you a number of times, but haven't done the podcast with you. So pretty cool to be here in this format. And so I'm looking forward to that. But yeah, the 401k. So look, it's a great tool, right? I mean it's a very powerful retirement savings tool, but let's talk about the fact that it is not perfect. And Isaac, when we say 401k, let's just let everybody kind of in on the fact that we're ... Let's throw the whole alphabet soup in just to make it easier. Talking 403bs, TSPs, 457s, but when we say 401k, we're kind of referring to all of these kinds of vehicles. So let's just point out a couple of the weaknesses to be aware of like administrative costs there. They're not cheap.
Isaac Wright: Well, and dependent upon the company that's offering and the company that you work with that has a 401k or a thrift savings plan or 457 you know, these various forms of plans that you can get involved in saving for your retirement, which is, again, I want to be clear is a good thing. And a lot of them now have the option of being able to invest money in a quote traditional plan where it's growing tax deferred and some of them now offer the Roth option, which allows you to put money away. Pay the tax now and of course have that money in the future tax free, if you play by the rules of course.
Isaac Wright: But the underlying thing that I want to be clear about is when it comes to a 401k, and this is predominantly what I see is just some of the unknowns where people walk in, they're trying to make a decision, does it make sense to leave money in an employer plan? Does it make sense to roll over money into an IRA? And I just want to point out some consistent things that I see on 401k. Is that people sometimes don't always know. And so when we're talking number one about administrative cost, depending upon your employer, sometimes it's ... And whether you know this or not, it's not necessarily cheap for an employer to offer a plan on the 401k chassis sometimes.
Isaac Wright: So you normally have costs that sometimes and in the past it's never been sometimes disclosed, let's call it these underlying administrative costs can be passed onto you. Normally the smaller the company, the higher those costs are going to be for each person just because of scale and because you just don't have a situation where let's say, now and I think this is being changed on a lot of different plans. You may want to pay attention to this if you have a 401k. Is that they are doing a better job of disclosing fees. I would say that they're not all the way there yet, but administrative costs can absolutely be something that you need to pay attention to when it comes to the portfolio itself or the 401k itself.
Mark Kilian: Yeah, absolutely and again, scale of the size of the business kind of goes into that to some degree, but we'll keep on with a couple of just bullet points here about a few of the weaknesses you might find in the 401k. And some mutual funds. Let's just talk about those. You're going to find that there's just not a lot else. I mean, you might have, I don't know what 20 options or so maybe.
Isaac Wright: And sometimes not even that, but yeah, just the backup on a mutual fund. A lot of times when you have a 401k, you primarily have mutual funds as an option. Okay. You may have an option to buy company stock. You may have an option to maybe put money in a cash or money market or stable value fund, but a majority of the investments that you're going to choose to buy stocks and bonds typically come in the form of a mutual fund. And the limitations of those choices can be pretty apparent. So a lot of times 401ks will offer you different, let's call it options to participate in different asset classes within the stock market, but normally that's limited to stocks, bonds.
Isaac Wright: Number two is when you have, let's say the money in just those quote unquote mutual funds, it can make it difficult again, sometimes to know what those costs are. Those mutual funds have underlying portfolio fees, manager costs. It can vary quite dramatically, Mark, I think for all of you listening. You can have fund fees of a quarter to a half a percent all the way up to two to three percent a year. You may not be aware of that. Or of course when you get your 401k notice or the options you have, they've tried to be better about disclosing those fees as well. But just know that outside of a 401k you may have a very good option to be able to open up an IRA and have very low cost funds or ETFs or you can buy individual stocks and that's sometimes, in a lot of respect, when you leave or you separate service from your employer. That's a strong consideration of why you want to have money potentially rolled over to an IRA.
Isaac Wright: So just keep that in mind. You have administrative fees, you may have additional mutual fund fees and a limitation on the overall amount of mutual funds, or let's call it more importantly, investments that you can choose from.
Mark Kilian: Okay. And talking about that, we'll stay with that theme, Isaac for a minute. So when you're thinking about some mutual funds, a lot of times we'll see people who have ... They'll say, "Well, I'm diversified because I've got 7, 8, 9, 10, 12 however many mutual funds." And a lot of times it's just large cap and there's a lot of overlap with companies in there. So there are ... 401ks do have limited asset classes I guess is my point.
Isaac Wright: To be a little bit more fair to the 401k. Most 401ks when they give you the menu of options for the funds you can choose. So if you had these mutual funds, they'll give me an option for let's say a large cap fund, a mid cap fund, a small cap fund, maybe an international stock fund. These are all stock asset class options with inequities. So you have all of those options normally. But most plans don't really allow you to diversify into other asset classes. A lot of times you're going to just be able to own traditional stocks or stock funds and maybe traditional bond or bond funds. And have that stable value account. And again, you may have the chance to own your own company stock, which dependent upon that situation may or may not be the best thing for you. But just keep in mind you probably do not have, or if you do, you may have a very limited amount of selection towards the following.
Isaac Wright: You may want to invest some of your retirement in a commodity index or owning commodities outright or real estate or having money invested through a fund that invest in real estate. Or health care or energy. You may want to have sector plays and again, just to reiterate, you may only have the chance to buy your company stock as an individual stock selection. That's the only thing you may have an option for. So you have a limited amount of investment options. But also what we normally find is a limited amount of asset classes that you can also choose from.
Isaac Wright: So again, when you're running around working 40 plus hours a week or trying to volley multiple activities, sometimes you may not necessarily look at your 401k as often or when you do, these are things that may or may not hit you initially, but you need to be aware of them. Especially, as you get to the point where you have some flexibility of whether or not you want to leave money in a 401k or again, roll that money over into an individual retirement account. So these things, Mark, I know we talk about them quite often, but I thought this was a good thing to kind of cover some bullet points here. I know we've got one more today, but yeah, just crazy how 401ks you would think that they would expand those options.
Mark Kilian: Yeah, no, I agree with you. And I guess that was going to bring me to ... And I'm glad you mentioned the last point, but when we're talking about some of the weaknesses to look out for. So again, they're a powerful tool. They're great tools, we should definitely be using them, but as we're aging and we're getting closer to retirement, a lot of people start looking for more conservative investments. Maybe to take some risk off. And you may find the 401k a little lacking in that department. Yes?
Isaac Wright: Yeah, that's a good point. For people, again, normally you are eligible to move money out of a 401k depending upon your plan document through your employer. Under two main circumstances. One is if you separate from service, so when you leave your employer, you normally can take your 401k and have that money rollover to another qualified plan without having to take a taxes into consideration.
Isaac Wright: Number two is if you are 59 and a half, so you may still be working, but if you're over 59 and a half, a lot of plans have the ability for you to take what's called an inservice amount of money and roll that over as well. Sometimes people don't recognize or know that, but as you get older, so let's say you are 59 and a half or older. You may decide, especially on the nice run we've had in the market for many years in a row that you want to start, let's call it having some money invested in a fashion where you can keep it a little bit more conservative. To where you don't have to worry about a stock market crash ruining 25, 30 plus years of saving.
Isaac Wright: So in your conservative investment options in your 401k, you may have a maybe a bond fund, depending on the type of bond fund, it could be still pretty volatile, but normally you only other have, and sometimes even 401ks don't even offer this, but a stable value or money market fund. Now, if you've been paying attention to interest rates here as of late, they're starting to move back into a direction that literally is paying little to no interest. And all of us as we have saved money, want to be able to have what I call that money work for us constructively, which means is collecting money dividends. Income distributions off of that money that you save for retirement to live on. That again may be a problem if it's in the 401k and you don't have but maybe one or two options.
Isaac Wright: So having a multitude of more conservative based options. Again, diversifying that money also can help lower the overall risk of your portfolio that's earmarked for your retirement lifestyle. These are all things that we do at our firm more than you want to shake a stick at. I mean, so even though I know we do a podcast, our firm right here in Richmond, Virginia. Financial Dynamics and Associates does allow you to have what I call some clarity around does it make sense to make some of these decisions? And if you have any concerns, questions, again reach out. You can give us a call at (804) 777-9999. You can reach out or you can just go to wrightmoneytips.com and it'll forward you over to our site.
Isaac Wright: So Mark, as we wrap up here, I like what you just said, 401ks, great tool, gives you options. Especially if you have a Roth option in your retirement plan.
Mark Kilian: Mm-hmm (affirmative)
Isaac Wright: But in the construct of how to invest your money, we can help you if you are in a position where you don't have the ability to roll over money in a 401k. How to help at least balance and let's say properly manage that out for you as you start moving closer to retirement. For those of you here that are already 59 and a half are separated from an old employer, I hope this has been helpful. Definitely want to pay attention to what I've covered and reach out if we can help in any way. So Mark, with that being said, man, I think that covers it all today.
Mark Kilian: I think so too. Thanks for your time here on the podcast. Good information around the 401ks. Again, a great tool. They just have a few weaknesses to be aware of, and of course Isaac as he mentioned, reach out to him. Great thing about a podcast too is you can always rewind and listen to parts of it again or reach out to him a couple of ways, as he mentioned, (804) 777-9999, or go to wrightmoneytips.com. This has been another edition of the Wright Money Tips Podcast with Isaac Wright and we'll see you next time right here on the program. Thanks.
Announcer: Information is for illustrative purposes only and does not constitute tax investment or legal advice. Always consult with a qualified investment, legal or tax professional before taking any action.
Announcer: Advisory services offered through JW Cole Advisors Inc, JWCA. Financial Dynamics and Associates Inc. and JWCA are unaffiliated entities.
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