When to Withdraw Funds With a Set Date in Your 401 (K)
Automatic enrollment has proven to be an effective way of saving for retirement for employees, with 91 percent of those automatically enrolled in a defined contribution plan (such as 401 (k)) still enrolled in the program, according to Fidelity’s 2018 Report .
But this has implications not only for more people saving for retirement – it also affects what funds and investments employees go to. Auto enrollment plans work by inertia. With 98 percent of employers offering fixed-term funds in defined contribution plans and 89 percent using them as their default investment option, this means more and more day-to-day investors are investing more and more of their investments in fixed-contribution funds.
In fact, “68 percent of millennials are 100 percent invested in a trust fund, in part because they automatically signed up to their 401 (k) and didn’t exercise the option,” Fidelity reports. Overall, more than 30 percent of 401 (k) assets are held in due date funds, up significantly from about 10 percent in 2008. And the participants in the 403 (b) plan have an even larger share of the assets invested in the IVS.
So is it bad? Not necessary, but it depends on who you are and what your goals are.
Date Defined Funds are Easy to Use
Basically, TDFs take into account the age of the investor and the estimated year of retirement when choosing an investment. For aspiring investors, they provide an easy and manageable way to access multiple investments and spend less time researching and selecting individual funds. They have a low minimum initial investment, automatic rebalancing and asset allocation adjustments over time. They are simple and don’t require a lot of investment savvy.
But beyond that, TDFs are losing some of their luster. Once you’ve started building your assets, you should consider ditching them. First, because “being in the IVS, you have no control over how this fund is invested,” says D. Keith Lockyer, investment market manager at PNC Wealth Management. Your individual risk tolerance is not taken into account, which means, especially for older investors, that your portfolio is probably too conservative (you can also argue that this applies to younger investors who do not need as much bond investment as they need it) everything will fall). Outside of TDF, you or a professional can tweak things the way you want in the “best” funds.
“Expiry funds are kind of a thing that ‘turns off my brain’, but when we shut off our brains, bad things happen,” said Scott Tucker, president of Scott Tucker Solutions in Chicago, Illinois. “People use fixed-term funds to grow, and the problem is that fixed-date funds hold a lot of bonds, and bonds lose value when interest rates rise.” This means that people looking to retire soon (say, by 2025 or even 2030) potentially lose significant growth by continuing to invest in them.
When to Withdraw Funds on a Set Date
They are also actively managed – which LH advises against – which means they can be charged higher fees than a regular index fund. One big difference in pay: cost ratio. The Motley Fool reports that the difference between the annual spending ratio of the trust fund and the index fund is “0.51 percent versus 0.09 percent on average, according to the Investment Firms Institute.” This may not sound like much, but consider this simple example:
You are saving $ 5,500 a year for the next 30 years. Your funds are earning 7% per year above inflation before commissions (near the historical average of the stock market). In the index fund scenario (that is, with an expense ratio of 0.09%), you get just over $ 511,000. If you pay the higher expense ratio of 0.51%, then all other things being equal, you have just over $ 474,000 in savings – a loss of about $ 37,000 due to those additional fees.
However, the fees for these funds can easily be as high as one percent or more, which eats up even more of your money. You should always check your commission before investing in any product.
One solution for older investors (59 1/2+) and those who quit their jobs is to put their 401 (k) into an IRA, Tucker said. This way you will have the best investment options. And young investors should choose the highest retirement year in date-bound funds, he suggests, even if it isn’t necessarily the year they want to retire, so they can invest more in stocks and have less in bonds.
“We’re trying to make investing easier for people who have time-bound funds, but investors will want to look under the hood,” says Tucker. “A simple button isn’t always the best option.”