Last Updated Mar 2, 2011 12:19 PM EST
An impressive bunch of retirement experts have expressed plenty of skepticism that moving public employees into 401(k)s would be good for either government or employees. But that's not necessarily going to slow down the anti-pension fervor.
So with the prospect of millions more Americans entering the nothing's-guaranteed-and-everything's-confusing world of 401(k)s, it seems a good time to run through the hallmarks of a crummy 401(k). Whether you're a public-sector employee new to the genre, or an old hand with years of contributions under your belt, here's what you need to be on the lookout for - and, where possible, ways you can counteract your plans' shortcomings.
1. You Can't Start Contributing from the Get-Go
Some plans make new hires wait six months to a year before they can start contributing their own money to save for their own retirement. I'm not talking about the employer matching contributions - we'll get to those in a moment. This is simply about letting workers save their own money. Any plan that does this and yet still pays lip service to caring about workers' retirement security is full of it. If you expect to land at a new job in the near future and will be closed out of the 401(k) for a bit, try to max out on an individual retirement account ($5,000 limit in 2011; $6,000 if you're 50 or older) and then keep saving more in a taxable account.
2. No Auto-Enrollment
In a perfect world of perfect savers, none of us would need any nudge to save for retirement. Yet there's an entire field of economists flourishing on campuses across the country whose careers are spent studying the fact that's not what we're hardwired for. A way employers can help employees is to automatically enroll employees in the 401(k) rather than wait for the employee to rise from inertia and get around to filling out the forms. Offering auto-enrollment is a sign that your employer has your back. No auto-enrollment, and you're new to the plan and locked out for month or year? Follow the advice in No. 1 - but also check with HR for the first date you will be eligible, then set an alert on your calendar to get yourself enrolled on that date.
3. It Doesn't Help You Save More
At the risk of stating the obvious: Americans aren't saving enough for retirement. One way a 401(k) can help employees get better at this is to automatically increase the amount of salary a participant contributes into the plan. A plan with auto-escalation might ramp up your contribution rate from 4 percent this year, for example, to 5 percent next year and 6 percent the next. Or it might trigger an increase every time you get a raise. Yet plenty of plans still aren't offering this assist.
More troubling is that many 401(k) plans that have auto-enrollment set the contribution rate at just 3 percent or 4 percent and then leave it stuck at that ridiculously low rate. That borders on irresponsible. It's one thing to start the employee at a low rate, but an unintended consequence of auto-enrollment is that it telegraphs to employees that the plan is making all the right moves on your behalf. A static 3 percent contribution rate is a recipe for retirement failure.
The fix is to set up another calendar alert: an annual date on which you contact HR or the plan and increase your contribution rate. Your ultimate goal should be to contribute at least 10 percent, and probably 15 percent, into your retirement plan.
4. It's Not Chipping In
Most employers do indeed offer a matching contribution, but not all. If yours doesn't, I'd focus on saving up in an IRA first; it's not like you're missing out on something by skipping the work plan - and with an IRA you have total control over picking a great low-cost index fund or exchange-traded fund.
If you do have a match, are you sure you're contributing enough to get the maximum match from your boss? A really great plan would tell you upfront what you need to contribute to get the maximum match. But that's not something plans offer up. Check with HR if you're unsure whether you're getting the max.
5. No Low-Cost Index Funds
What you pay to invest is one of the biggest factors in your success. Every decent plan should offer at least one low-cost fund, with an expense ratio below 0.50 percent. And to be clear: Many index funds carry fees below 0.20 percent; I was just going easy with the 0.50 percent threshold.
6. You Have to Pay Retail
Most mutual funds come in two flavors, or share classes. Retail shares have lower investment minimums, but higher annual expenses. Institutional shares typically require investments of $1 million or more, but if you meet that threshold your annual expenses can be half or less of what the retail share class charges. Here's the thing: If a company has a ton of employees participating in a 401(k), its collective contributions are gonna be way more than $1 million. There's no reason you all shouldn't be getting the cheaper institutional shares.
7. No Estimate of Your Retirement Income
The lump sum value of your 401(k) plastered on your statement is actually sort of meaningless. What matters more is what sort of sustainable income stream in retirement you might be able to tease from that sum. The folks running your plan are more than capable of producing these estimates for you and slapping it on the front of your statement in a large font. Indeed, some plans already do this. Good on them.
If yours doesn't, you should ask why. Knowing what sort of annuity you might be able to generate based on your current savings is the key to knowing whether you are on track. With old-fashioned pensions there was no guesswork; it all just boiled down to a simple formula. Now that our retirements are increasingly riding on 401(k)s, the least plan sponsors can do is help employees understand how much money they might have to live on in retirement.
8. No Target-Date Funds
I am well aware of the purported shortcomings of target date funds. I just happen to think a bigger shortcoming is having participants so confused by the dozen or more mutual funds offered in their plan that they make bad allocation decisions - or, worse, just avoid participating in the first place. One-and-done target-date funds are a great option you should be able to choose.
9. It Pushes the Company Stock
This is one problem public-sector employees won't have to deal with. For everyone else, if your plan makes the matching contribution in company stock, it should also make it clear that you can move the money into other options within the plan. And though this is a bit of pipe dream, it sure would be a sign of responsibility if employers aggressively communicated to participants that having more than 10 percent in any single stock breaks all sensible rules of diversification.
It is amazing to me that we still keep hearing stories of employees with way too much in company stock. It's not just the old examples of Enron and WorldCom; just last year it came out that BP's 401(k) had about 30 percent riding on company stock.
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