Providing a relatively painless way to save for retirement, employer sponsored 401(k) plans continue to be one of the most popular ways to stash cash for our later years in life. According to the Investment Company Institute’s 2014 annual report, as of last June, 401(k) plans held an estimated $4.4 trillion in assets.
If you have a 401(k) through your employer, you may assume that since you have an account and contribute regularly that you’re all set to eventually enjoy a comfortable retirement. Not necessarily. All plans aren’t created equal. Some are better equipped to grow your money than others. Knowing where your plan stands helps you determine if contributing to this investment vehicle fits with your overall financial goals.
You can use the following criteria for determining if your 401(k) is worthy of your hard earned dollars.
When Can You Begin Contributing?
Does your plan offer immediate or timely eligibility once you start working? Ideally, you should be able to begin contributing to your company’s 401(k) plan within the first three months of commencing work.
According to research conducted by the investment management company Vanguard, which was published in their report on 2012 defined contribution plan data, 54 percent of 401(k) plans offered immediate eligibility for employee contributions. If your plan requires more than three to six months of employment prior to eligibility, it may be inferior.
Does Your Plan Offer a Match?
The main reason for taking advantage of a 401(k) plan rather than an IRA, is the company match that is commonly offered by the employer. According to the Vanguard report, 91 percent of employers offer a company match contribution, which is essentially free money.
Ideally, your employer will offer matching contributions as soon as you open the account, but that doesn’t always occur. Twenty-eight percent of plans require a year of service before matching occurs, according to the Vanguard report. The longer you have to wait for this benefit, the less lucrative the plan.
What’s Your Plan’s Match Rate, and Can You Take Full Advantage?
Another important question to ask is what your plan’s employer match rate is. With most 401(k) plans, you’ll find a matching rate of 50 cents for each dollar contributed, up to a maximum 6 percent of your pay. Your company’s 401(k) may not be a good one if it offers a lower percentage for the matching rate.
Also of consideration is whether you can take full advantage of the match. Generally, plans require that you contribute a certain percentage in order to get the maximum match amount. Some plans require that you contribute 6 percent of your pay to the plan, while others call for less and some more. How much of your pay you can afford to contribute will depend on your budget.
Are Fees Reasonable?
Due to realities like compliance issues and administration, transaction and investment fees, 401(k) plans are expensive undertakings. Some fees are absorbed by employers, while other costs get passed on to plan participants. The fees you pay can add up to substantial amounts of money over time.
Generally you will find that the larger the plan, the lower the fees. Many large company plans feature 1 percent fees for your contributions, whereas smaller companies often cost up to 1.5 percent in fees.
Take a good look at the fees you’re paying with your 401(k) to ensure that the costs aren’t eating into your savings. The U.S. Department of Labor requires that all plans must give investors information that explains the fees associated with each investment option in the plan. You’ll find fees charged to your account on your statements.
You can also check your plan’s fees and overall quality against other plans on BrightScope.com or AARP.org.
Does Your Plan Include Affordable Investment Options?
Low-cost investment options are the hallmark of a good 401(k) plan. Low-expense funds (such as index funds), are an important ingredient of most retirement portfolios, because by having such funds as a foundation, the amount of money you save in fees adds up to more over time than if you were to invest in an actively managed fund that features higher fees. Most good 401(k) plans offer at least six fund options, including index funds. If your funds are in a single investment or your options are significantly limited, beware.
Vesting is required in 401(k) plans prior to being able to collect employer contributions from the fund. A good plan allows for immediate vesting or vesting on a short timeline. This means, for instance, if your plan is fully vested at six months, that even if you quit in the seventh month, in addition to your own contributions, you receive all of your employer’s contributions.
9 Signs of a Bad Plan
Occasionally, the Department of Labor discovers fraudulent 401(k) plans. Here are 9 warning signs that your plan may fall into that category:
- Your account statements are late or inconsistent.
- Your account balance looks incorrect or has dropped significantly for no apparent reason.
- Your employer fails to make contributions of your money to the plan in a timely manner or your contributions don’t appear to make it into your account.
- A significant drop in account balance that cannot be explained by normal market ups and downs.
- Unauthorized investments appear on your statements.
- You see unusual transactions on your statements, like loans that you didn’t take out.
- Former employees are having trouble getting their money.
- The investment manager has changed several times.
- Your employer appears to be experiencing financial difficulty.
A well-run 401(k) provides you with an ideal opportunity to save money for retirement and get rewarded for your efforts with an employer match and lower taxes taken from each paycheck. Now that you know the signs of a good fund, as well as some of the warning signs of a bad one, you can ensure that your company’s plan is up to the task of safeguarding and growing your savings.
Julie Bawden-Davis is a widely published journalist specializing in personal finance and small business. She has written 10 books and more than 2,500 articles for a wide variety of national and international publications, including Parade.com, where she has a weekly column. In addition to contributing to SuperMoney, her work has appeared in publications such as American Express OPEN Forum, The Hartford and Forbes.