Recently a few of my clients at major tech companies (to remain nameless!) have forwarded to me company emails proclaiming the latest improvements in their 401(k) offering. These improvements have included a “true up” of matching contributions and dead-easy-to-use after-tax-401(k) contributions.
Despite being a little leery of “Are you sure the IRS is cool with this?” I am really happy for my clients, because these changes make their 401(k) even More Awesome-er than it was before: making it even more easy to save even more money in an even more tax-savvy way for their eventual financial independence.
I have previously written about what makes a 401(k) crappy. But these emails from clients got me to thinking: If I could construct the best 401(k) out there, based on elements that I actually see in existence at tech companies right now (this is not pie in the sky, this is based on reality), what would it look like?
[Side note: if you ever get a chance to participate in the 401(k) committee at your company, here’s a great template to start with! You could join me in thanking my many colleagues in the XY Planning Network community, who helped me flesh out this list.]
As I was discussing this blog post with colleagues, I realized that features could be good in two ways: good for the employee, or good for the financial planner the employee is working with. Oftentimes, I‘d say, features are both: that which is good for the employee is also good for the planner, assuming the planner is a true fiduciary and puts their clients’ best interests first. Regardless, this blog post focuses exclusively on features good for the employee (that is, you) regardless of whether you work with a financial planner.
You might be a bit surprised (and overwhelmed) by the number of features that I include below. So, if you do get overwhelmed, keep just this short list of features in mind. A really good 401(k) provides:
- It’s easy to understand how it works, how to enroll, how to contribute, how to manage the account.
- The list of investment options is short.
- The website interface is easy to use.
- Low cost investments and plan fees
- A good match.
- I’d say an all-up 4% match is base level good. I’d love to see higher.
Let’s Make it Awesome-Er.
All the things I list below I’ve either seen in my clients’ 401(k)s or seen at play in other 401(k)s. Which is to say, this is all very reality-centric. I’m not just making sh*t up.
A Good Match
- A match above 4% total (companies might define this in different ways)
- Matches are “trued up” at year end. That is, you don’t have to contribute in every paycheck in order to get the full match.
- Immediate (or fast) vesting. I cannot remember seeing a tech-company 401(k) that didn’t provide immediate vesting, but my husband swears they exist.
- You receive a 401(k) match not because you contributed, but because you’re paying back student loans. (“Whaaaat?” you say. “I know,” I say.)
You Can Contribute in Many Different Ways
- Contribute to a Roth account, not just a pre-tax account.
- Make after-tax contributions
- Even better, you can do “in-service distributions” to roll that after-tax money into a Roth IRA every year.
- Even better-er, the plan will immediately and automatically convert after-tax contributions to your Roth 401(k).
- Roll former 401(k)s into it (“rollover contributions”).
- Contribute to your 401(k) from bonuses, not just from salary.
A Short List of Good Investment Choices
“Good investment choices,” to me, means:
- Low-cost: ideally well under 0.50% expense ratio
- Set-it-and-forget-it: usually this means either target-date retirement funds or “balanced” funds. Broad-market index funds (either stock or bond) are good, too…you just have to figure out the right balance for yourself.
And, perhaps counter-intuitively, you want a short list of investment options. Behavioral finance research has shown us that more choices makes us unhappy and less likely to take action (in this case, choose an investment in your 401(k)). Many 401(k)s have a bewilderingly long list of investment options; this is not actually doing you a service.
(Having a “brokerage window” into the broader universe of investment options at Fidelity or Vanguard or whoever manages your 401(k) plan is only useful if your 401(k)’s investment options aren’t good. If they are good enough, the brokerage window just confuses things unnecessarily.)
Low, Transparent Fees
Fees live in two places in your 401(k) plan:
- The fees needed to run the plan
- Fees associated with the individual investment options
Sometimes these fees are kept separate, and sometimes the plan is “free” because the investment expenses are raised to cover plan fees. I don’t have a horse in this race: it legit takes money to administer a 401(k) plan like this. That money’s gotta come from somewhere.
In any case, ideally the 401(k) plan documentation makes clear what fees you’re paying and what these fees are for. So, I suppose that’s one knock against the “free” plan…because the fees for investments are muddled up with the fees for running the plan. In some cases, your company pays the plan fees and you only owe the investment fees.
Easy-to-Use, Informative Interface
Honestly, this is a little hard to come by. I’m no UX designer (though I have several clients who play one on TV), but the web interfaces for 401(k)s are often overly complicated and difficult to intuit.
- If you switch jobs mid-year, I really appreciate the feature that allows you to record contributions to the previous 401(k) so that you don’t have to worry about over-contributing to this 401(k).
- Plan documents and important information are easily accessible through the interface.
- The website (and statements) tell you how much income, in retirement, your current account balance would translate into in terms of monthly income. If you’re young or new to the 401(k), this is probably a depressingly low number. But it’s good for perspective and combatting Wishful Thinking.
- Easy-to-understand statements
The Plan Makes Good Decisions on Your Behalf
Thanks to work in Behavioral Finance, notably Nobel Prize Winner Richard Thaler, many 401(k)s have implemented automatic actions that save you from your inertia or other self-sabotaging behaviors. Just goin’ on the record here: These are good. They include automatic:
- Enrollment. You have to opt out of participating in your 401(k). 401(k) participation typically goes through the roof when this is implemented.
- Investment selection. Instead of your contributions just sittin’ there like a dolt in cash, they are automatically invested, typically in a target-date fund with an appropriate year given your age. Obviously, depending on your personal circumstances, this might not be ideal. But in general, it’s hell of a lot better than the usual “cash” default.
- Contribution percentage. Now, The usual default contribution percentage is usually around 3%, which is still waaaay too low for all of my clients. But it’s sure better than the 0% you’d get otherwise if you neglected to set it yourself.
- Escalation. Let’s say you should be saving more to your 401(k). It’s really hard to proactively cut your spending in order to save more. So, some plans allow you to automatically increase your contribution a certain percentage every year or every time you get a raise. ‘Cause, as we all know, it’s easier to “Save More Tomorrow” than it is to save more today.
If your 401(k) offers all of these features, please let me know so I can send a bouquet to your HR department.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.