I’d like to think that 401(k)s at high-tech companies would be inexpensive to administer, provide employee-friendly interfaces, and be full of broadly-diversified, low-cost funds.
I mean, the industry is full of tech savvy, presumably smart people who, in my experience, tend to know more than the average bear about investing. Alas, there are some reeeeal doozies out there.
In the tech industry, your net worth tends to be concentrated in two places: 401(k)s and homes. If one of those things is crappy, that’s, well, not good. But there are ways to improve the situation, even if you’re stuck with a crappy 401(k).
How do I know if my 401(k) sucks?
Some of you already recognize your 401(k) is bad. But just so we’re all on the same page, these are earmarks of a craptastic 401(k):
You have difficulty getting access to information, either printed, online, or by phone (that thing you pick up and speak into, and someone speaks back to you…of generally poor voice quality in the world of cell phones). The dollars and cents of the 401(k) plan are, of course, very important. But the service is also important!
I worked at a startup that had great investment options but, lord, the third-party administrator who managed the thing for us was so hoooorrid. Confusing website. Difficult to talk to a human. Required so much more persistence and energy to do the basics, which would inevitably make some people just give up on their 401(k).
The investment options are expensive. Frankly, funds with expense ratios greater than 0.50% are suspect in my book.
The investment options are narrowly focused. The vast majority of people simply don’t need funds more specific than a fund covering the entire US market, international market, and US bond market. Ideally, there are target-date or balanced funds that you can “set and forget.” I’ll allow for a S&P 500 index fund or Vanguard small-cap index fund, but funds specific to an industry or a country? Usually not helpful.
The plan charges you significant fees. Somebody has to pay fees, because this is a service being provided to you; that’s fair. It’s the hidden or high costs that are problematic. The 401(k) provider gets paid either through the investment expenses or from explicit plan fees. This WSJ article indicates median fees for plans by asset size (how much money is invested in them). It can give you a good comparison for your own 401(k).
The plan comes along with “free”advice from the company that provides the 401(k). This sort of thing is probably going to be a lot less common now that the Department of Labor has imposed the fiduciary standard (“I put your interests before my own”) on anyone advising on 401(k)s. The rules, until very recently, didn’t used to be in your favor, let me assure you.
No company match. This is what it is. If your company matches, you’re lucky!
Your ability to make changes in your account is restricted. Some plans restrict your ability to change your investments to, say, once a quarter. I gotta admit, though, this is not necessarily a bad thing. There’s almost never a good reason to be changing investments more often, and you should probably only touch them annually. Sometimes these restrictions protect you from yourself!
Educate yourself first. You might not know the full story of how good (or crappy) your 401(k) plan is until you ask outright for the information I mention above. Fees are an important issue and, unfortunately, they’ve often hidden from you. Ask your HR or 401(k) plan representative to explain the plan’s ins and outs to you, especially fees, at both the individual investment level and at the plan level. What fees are passed on directly to you, the employee? What fees does the company pay directly?
Bring out your inner Activist Investor. Try to change the 401(k). When I worked at a start-up, they asked interested employees to help choose investments for the 401(k). That’s the best kind of situation. Well, assuming your fellow employees aren’t a bunch of nitwits. (Thank you, now-defunct nCircle Network Security. The 401(k) administrators might have had the Worst Website Ever, but the investment selections were lovely!)
Talk to your HR department. Ask how the 401(k) investment options were chosen. Ask if there’s a process for reevaluating the plan and how (not if) you could become involved. And come prepared with persuasive documentation supporting the kind of plan and investments you want.
The Bogleheads forum has a great wiki page on this very act, including a template for a letter you can submit to the person in your company responsible for the 401(k). (The Bogleheads is an online forum of people who believe in Jack Bogle’s philosophy of keeping investment simple, low-cost, and broadly diversified. Mr. Bogle founded the first index fund and the investment company giant Vanguard.)
I spoke with a woman in HR at a high tech company, and she had this advice: “the best time to bring it up is when your company is taking away other benefits. For example, our company recently introduced higher percentage of cost sharing on our insurance premiums. We heard from a lot of employees that if we are expecting employees to share in the cost of employee premiums that we should be sharing in the cost of retirement savings. Also the employee survey is a great time to bring it up. The [more] voices we hear, the more of a case we have to bring to the execs.”
Keep in mind that especially at small companies, the 401(k) might be just One More Thing that the small HR department is in charge of. These are not investment experts, folks. Even if your 401(k) is crappy, it’s likely out of ignorance or lack of leverage, not for some nefarious reason. That’s one reason (in addition to just basic human decency) to proceed respectfully and with educational materials when you’re trying to encourage a change in the plan.
Criticism is usually better accepted when it’s constructive. So, what can concrete suggestions can you make? Specific investment selections (index funds, target-date funds or balanced funds made up of low-cost funds). Third-party administrators (ask your friends who they have that’s good).
Betterment has recently launched its own “turnkey 401(k) service,” which promises the low fees and easy user interface that its retail business has been providing the last few years. I don’t know much about it but generally am impressed by Betterment’s core business. It’s definitely worth investigating if your 401(k) is plagued by byzantine bureaucracy and poor investments.
Is there at least one good fund? Invest there. This might look weird, but if you have investments outside of your 401(k) (in a taxable investment account, or in your spouse’s retirement plan), then your portfolio is more than just your 401(k). If the one good investment in your 401(k) is a total-bond market fund, then you’ll need to invest more in stocks in your taxable account.
If you follow this strategy, it’ll probably be hard to look at just the 401(k)’s performance by itself. For example, If the one good investment is stocks, then get ready for some rollercoaster performance. Try to focus on the performance on your household portfolio, not just individual accounts.
Use a “brokerage window” or “self-directed” 401(k). Instead of investing in the funds in the 401(k) plan, you can go through the “brokerage window” and invest in any of the myriad investments the larger broker/dealer has to offer, where surely you will find low-cost, broadly diversified funds. You’ll need to find out what rules and restrictions apply to using the brokerage window. Are there extra fees? A limit to how much money you can invest through the brokerage window? Etc.
Do an “in-service” rollover. This allows you to move some portion of the money in your 401(k) out to an IRA while you’re still working at the firm. Not all 401(k) plans allow this. This would ideally give you access to better, cheaper investments with better service, while retaining the tax advantages and ease-of-contribution of the employer 401(k). Attention to detail in the paperwork is necessary to avoid penalties.
Be aware that 401(k)s offer some important advantages that IRAs don’t. To name a few: protection from lawsuits and creditors, the ability to take a loan, and the ability to withdraw penalty-free in some situations at age 55. This is a pretty advanced strategy; I wouldn’t typically recommend it.
Contribute only enough to maximize your match and invest the rest elsewhere. You could save the rest to a traditional IRA, but if you’re covered by a retirement plan at work, your contributions probably won’t be deductible (and I’m talking to people employed in the tech industry, who are generally highly paid).
Making non-deductible contributions to a traditional IRA isn’t the worst idea in the world, but usually I would advocate saving to a taxable account which can still be done tax effectively. If your household income is below $194,000 (for 2016), you could contribute to a Roth IRA instead.
I definitely like having “tax diversification” amongst accounts with different tax characteristics: pre-tax (IRA and 401(K)), after-tax (taxable account), and tax-free (Roth IRA and Roth 401(K)).
The Nuclear Option. Lawsuit. Frankly, I wouldn’t really know where to begin on this one. But other people have begun. And won. Behold. With increasing attention on the cost of 401(k) plans and their investment options, more and more companies are being served. Hopefully, this means that companies are both more receptive to suggestions about improving investment choices, and more likely to change the offerings on their own before the Complaint Train gets rolling.
Keep in mind that this is a service being provided to you, and there are fair costs associated with providing that service. (You wouldn’t believe….or perhaps you would…the amount of regulation and therefore process and paperwork that companies must do to provide, administer, or manage 401(k) plans. This just plain costs money.)
Some companies are big or flush enough to cover the expenses themselves. But if your company is passing on the expenses, that doesn’t make it bad. In fact, the alternative is sometimes providing you a “free” 401(k) with hidden expenses that you don’t know you’re paying!
Additionally, if you work for a big company with lots of employees and therefore lots of money to be invested in 401(k)s, your company has more leverage in getting a good plan. The smaller the company, the less leverage, and probably the crappier the 401(k).
Your 401(k) would have to be Pretty Darn Crappy for me to recommend that you not use it or to use a workaround. It has so many advantages, beyond the obvious tax-deductible contribution: You can take loans from a 401(k); You can take penalty-free withdrawals starting at 55 under not-too-restrictive circumstances; The contribution comes directly out of your paycheck and therefore you’re more likely to save than if you had to move money manually.
What You Should Do, Regardless
Good, Bad, or Middlin’, you need to know how your 401(k) works and who is paying what fees. How can you do that, pray tell? Ask HR to break it down for you, or direct you to the person who can. Research your company’s 401(k) on Brightscope. The larger your company, the more likely it is their 401(k) has been evaluated on this website.
Do you suspect your 401(k) sucks? Let’s figure out how to take advantage of your 401(k)’s many advantages while mitigating the bad parts. And while we’re at it, let’s position your 401(k) where it belongs in your overall financial picture. Reach out to me at firstname.lastname@example.org or schedule a free 30-minute consultation.
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This article is provided for general information only, and nothing contained in the material constitutes a recommendation for purchase or sale of any security, or investment advisory services. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.