Personal Finance

The 401(k) Crisis and What You Can Do About It

If you're like most Americans, you want to retire someday, and you're trying to do it by stuffing as much of your paycheck as possible into your employer-sponsored retirement account. Whether it goes by the name 401(k), 403(b), or 457, your employer-sponsored account may grow to become your biggest asset -- even as it endures market ups and downs along the way. Unfortunately, the threat of future bear markets isn't the only thing holding back your 401(k); it may also be fighting hidden fees, lousy investments, and Wall Street kickbacks.

The sad truth is that the typical 401(k) is not a model of investment efficiency or transparency. Let's look at the problems that plague employer-sponsored retirement plans and what you can do to cure your plan -- and your retirement.

Problem No. 1: Your plan wasn't designed by an investment expert.

We love the hard-working folks who staff the nation's human resources departments. But most HR personnel are not investment experts -- and yet they often choose your employer-sponsored plan. Their choices may not necessarily be bad, but they may be looking for certain characteristics (e.g., ease of paperwork management) that compete with what you want in a plan: namely, a wide range of excellent, low-cost investments.

Problem No. 2: Your boss wants you to pay.

We don't want to talk smack about your employer, who, after all, doesn't have to offer a retirement plan. Doing so takes up valuable HR time and adds to expenses. To ease the burden, your boss may ask you to pick up more of the tab. As found in a study released by the Government Accountability Office (GAO), employers are increasingly shifting retirement plan expenses to their employees.

Problem No. 3: You don't know what you're paying.

Think you can just look at the expense ratios of the mutual funds in your plan to find out how much you're paying? Think again. Chances are that somewhere on your account statement or plan website, you'll see a phrase along these lines: "All returns reflect investment expenses but not plan expenses." Without your knowledge, money may be taken out of your account regularly to pay for the administrative costs of your plan -- and this won't show up anywhere on your statement.

Problem No. 4: Your funds bribed your plan provider.

Welcome to the shady world of Wall Street kickbacks, where mutual fund companies pay to play. According to the GAO, the company that administers the 401(k) "may also be receiving compensation from mutual fund companies for recommending their funds. ... As a result, participants may have more limited investment options and pay higher fees for these options than they otherwise would." The bottom line: Funds often make their way into 401(k)s because they paid the most in bribes, not because they made the most money for shareholders.

Problem No. 5: Your 401(k) is shrinking.

On top of all these structural problems with employer-sponsored accounts, past bear markets have raised the question: Are 401(k)s even a good idea? They essentially turn every worker into a portfolio manager. On one hand, this is very Foolish: Millions of Americans are taking control of their financial destinies. But on the other hand, we must acknowledge that not every American is up to the task due to a lack of time, interest, or knowledge. For this 401(k) thing to work out, workers will have to cozy up with a few good resources to learn about asset allocation and portfolio construction. And even then, the stock and bond markets will have to cooperate by actually increasing in value.

Take the pulse of your plan

If you want to know how your plan stacks up, start by asking your HR folks how administrative costs are paid and by whom.

Next, figure out whether your plan offers decent investment choices. Compare the performance of your plan's investments over the past three, five, and 10 years (if possible) to similar low-cost index funds or exchange-traded funds. For example, if you have a stake in a large-cap stock fund, compare its performance to that of the S&P 500 index. Measure your small-cap funds against the Russell 2000 or S&P SmallCap 600 index, and international funds with the MSCI EAFE index. If your funds aren't keeping up, your plan has inferior investments.

Take charge of your retirement

If your plan is subpar, all is not lost. Here are some of your options:

  • Transfer your money to a low-cost IRA if you no longer work at the company.
  • Invest your way with a "brokerage window," which allows employees to buy individual stocks and funds. Just watch the extra fees and commissions and make sure the benefits outweigh the extra costs.
  • Take advantage of the so-called "in-service distribution" offered by some plans. It allows employees to transfer money to an IRA while still working for the company.
  • Advocate for better investment options, a brokerage option, or even a completely different plan. Dave Loeper's Stop the 401(k) Rip-off! is an excellent resource. If your company has a 401(k) committee, ask to be a member.
  • Learn more about asset allocation and how much risk you have to take. In the meantime, a target retirement fund -- which provides a sensible allocation based on your retirement date and gets progressively more conservative as that date approaches -- is an excellent choice if offered by your 401(k).

Like it or not, no one is planning your retirement for you; financial independence is up to you. Improving your 401(k) is a great first step that can pay off big-time. If you shaved 0.5% in annual costs off your 401(k) and got another 0.5% from better investment options, assuming a balance of $68,000, you'd save $680 this year, not to mention future growth and contributions. So give your plan a checkup and -- if necessary -- work with your employer to get a better plan. Your nest egg, as well as your boss's, will thank you.

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This article was originally written by Robert Brokamp and published on Dec. 17, 2008. It has been updated by Dan Caplinger, who doesn't own shares of the stocks mentioned in the article.

The article The 401(k) Crisis and What You Can Do About It originally appeared on

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