How to Tell If a 401 (K) Plan Is Good for Your Company
You started a new job, and among the training videos and meeting new colleagues, HR handed you the documents for the company’s retirement plan. As great as your recruiter was, she didn’t seem to be very well versed in the details of your plan’s investment opportunities. So how do you know if it’s worth contributing or is it worth checking out another account?
This report from BrightScope , a finance company that compares 401 (k) plans, has the answers.
Does he have a match with the employer?
This is the most important consideration. As you’ve heard countless times, an employer match is “free money,” but I like to think of it as part of my compensation, a big part that I give away if I don’t pay the maximum amount my employer will match.
According to a BrightScope report, in 2015, about 90 percent of 401 (k) big plans were employer-funded, including about 80 percent of smaller firms. This is one of the biggest benefits, and if your employer doesn’t offer a suitable option, chances are you will want to look elsewhere for better investment options rather than settle for what your employer has to offer. To verify this, you will want to take into account the other factors listed below.
How do employers contribute?
Employers deposit funds into retirement accounts in different ways. The most common is overlap: you contribute to your account and then they will match you up to a certain percentage. For example, they can correspond to a dollar-to-dollar ratio of up to six percent of your paycheck, or 50 cents per dollar to four percent of your paycheck.
It is also possible that your company contributes automatically, whether you add something yourself or not. According to BrightScope, this is most common in midsize companies.
You will also want to consider an entitlement schedule or how long you need to remain an employee to get a match with your employer. For example, on a graded transition schedule, you earn a percentage of compliance for each year you work at your company. This way, you can “earn” 20 percent more from a match every year, which means that you are fully wealthy after five years of work. Other employers use a transfer of entitlement system whereby you are eligible to receive 100 percent after a specified period of time, say one or two years.
What are the investment options?
According to BrightScope, the average 401 (k) offered 29 different investment options, which is beneficial for employees as it gives you the flexibility and freedom to invest in local and foreign stocks and bonds across a variety of sectors, as well as in date-bound funds.
If your plan offers a lot less than that — the report notes 10 percent of plans with no more than 18 different options — you might want to look into an external retirement account.
(However, too many investment options can also be a bad thing, since people are terrible at making decisions. You want to see a mix of inexpensive index funds.)
What are the fees associated with the plan?
You knew we were getting here. Fees eat up a lot of your money and are one of the most important factors when planning a job. Even 10 basis points (0.1 percent) can significantly affect the size of your breeding egg in the future. Small and medium-sized firms tend to have higher commissions than larger plans (since the fixed management costs are spread across a smaller pool of investors), so it’s important that you know how much your commission is charging.
BrightScope found that the average total plan cost in 2015 was 0.88%, lower than in previous years (hooray!). However, 10 percent of plans are priced at 1.38 percent or higher, which is an outrageous figure and is generally associated with smaller firms investing less than $ 10 million (boo).
Between fees and investment options, it may make sense to contribute to the maximum employer match and channel any savings beyond that to the IRA or Roth.