Even With Limited Choices, You May Be Able to Ratchet Up Your Earnings

Do you know what you’re invested in? Many people check their pay stubs to make sure their contributions and their employer’s contributions are being made, but then pay scant attention to the details of those accounts.

Available Investments

Did you actively select investments? The default selection at many employers is the target date retirement fund closest to your retirement age, often estimated as 65. This may not be appropriate for you. You may be able to tolerate more or less risk, or plan on retiring much earlier or later. If you find yourself pre-invested in a target date retirement fund, take a look at the prospectus, or at least look it up on Morningstar to see if you agree with the mix of investments.

Even worse, the default option at some employers may be a stable value or money market fund. If you’ve defaulted into one of these, you’d better plan on working forever or saving everything you make because these funds return practically nothing at the present time. Yes, they’re safe investments in that you probably won’t lose anything no matter what the market. But they’re extremely risky because of the lost opportunity of having your money grow at a pace with the market (or better). In most cases, these funds should only be a very small part of your overall investment, if any at all.

There are good reasons to select individual funds. Let’s say you have investments outside of your retirement plan. What are they? Do you invest heavily in stocks? Then perhaps your retirement plan should contain some balancing bond fund investments. Are you opposed to international investments? A target date fund will have a not insignificant amount, so perhaps you should individually select U.S. based funds. Are all your outside funds in taxable accounts? Maybe your retirement fund should house some REIT investments. You should choose your asset mix based on your entire investment portfolio, not account by account. It’s all your money, wherever its segments are housed

Too many people look at the column for one-year returns and pick the funds with the highest one-year return. Don’t do it! Rather, prefer funds with the lowest management fees and scrutinize whether the 10-year returns are average or better for the fund type.

Many companies have decided that their workers aren’t very smart about choosing funds and the company doesn’t need or want to pay a provider to offer many choices. Over the past 10 years, the retirement account options I’ve reviewed have definitely narrowed. There are plenty of target funds and maybe a bond fund, U.S. stock and international stock, but you’re going to be hard pressed to find, for example, a REIT fund, small-cap, value or emerging market fund. You’ll have to make a choice based on what’s offered and manage other investments to fill in gaps. Some employers have chosen to change providers, under the guise of lowering costs. Often, this means lowering administrative costs of the plan provider, not lower-cost mutual funds. Employees are often notified that their current funds will be “transitioned” into the newly available funds or at least the current funds will be closed to new contributions. You should carefully review this to make certain the new options resemble what you wanted to select.

As of now, most retirement plans don’t offer the ability to purchase individual stocks or exchange-traded funds, which also require brokerage access. Your choice is probably limited to mutual funds. It’s easiest to get information on publicly traded funds with ticker symbols and the information will be more up to date on Morningstar than any once-a-year information sheet your company issues. Some employers, especially banks, governments and insurance companies, have proprietary funds usually only pitched by type of investment: bonds, stock market, etc. It’s difficult to know exactly what is in these funds, which can change at any time, and to get regular performance data. You’re a captive market.

Timing and Trading Windows

If your retirement plan options are mutual funds, you won’t be able to time exactly when or at what share price your contributions are invested. Contributors’ investments will be aggregated and funds purchased on some schedule. You might ask your employer how often or what that schedule is. But optimum market timing is not something any investor can predict, so concentrate on your mix to reflect your risk tolerance.

According to Vanguard, as of 2019, less than 20% of employers offered a brokerage account option and of those only 1% took advantage of the option, so it’s easy to see why this hasn’t been a strong industry trend. If your employer offers this, you have a far wider range of choices — indeed, almost any conventional investment — but also incur more risk and maybe significant trading costs. This option isn’t for the faint-hearted and you should be very careful to understand what costs you’ll be charged and how rapidly orders will be executed.

The Employer Match

It astounds me that very few clients, even sophisticated investors, know exactly what their employer match is. Does your employer match a percentage of your income, a percentage of your contribution or a fixed percentage of your salary? Are there limits? Let’s say you make $100,000. I have seen all of the following:
  • A fixed contribution whether or not you contribute (one very generous one was 8%). Contribution = $8,000 +whatever you choose to add. If you contributed 6%, the total contribution would equal $14,000.
  • 50% of what you contribute. So, if you contribute 6% of your salary, they contribute 3%. Contribution = $9,000.
  • Any variation of match — you contribute 3%, 5%, or 7% but no matter what you do, their contribution is 1%. At 6%, total contribution = $7,000.
  • No employer contribution at all. I see this most frequently with 403b plans when there’s also a pension, or 457 plans. These are primarily ways to shelter income from current taxes. A 6% contribution = $6,000.
What your employer contributes can make a huge difference in your total return, as well as how rapidly total funds might accumulate. The employer contribution is an immediate return (e.g., 50%, 100% or 33%) but also takes some of the savings burden off you. In evaluating a job, it’s worthwhile considering this “free” money as part of the offer.

It depends on the employer match and your income eligibility for a Roth, but I often suggest funding the retirement plan to get the full employer match. Next, fund the Roth individual retirement account as much as you are able. If you still have more ability to save, then consider increasing your percentage in the retirement plan.

Many employers now offer a Roth 401(k) or 403b option. This does not affect your ability to contribute to an individual Roth. A workplace Roth has higher contribution limits, same as the traditional 401(k). Only your employee contribution will go into the workplace Roth; your employer’s matching contribution will go into the traditional plan, taxed upon withdrawal.

Vesting

With some plans, you’re immediately vested. This means that whenever you leave the job, you can take not only your contributions, to which you’re always entitled, but also the employer match. Beware! Employers know that many employees don’t stay in the same job for long periods. You should check whether your retirement plan has a vesting provision. I’ve seen some plans where, if you don’t work for the employer for a specific length of time (anywhere from three to 10 years), the employer will claw back the entire match and you’ll have only the money you put in. In some cases (a local school district), you won’t even be entitled to any return earned. Others claw back only a portion of the employer contribution.

This is a real penalty, especially for younger employees who may change jobs more frequently while building their careers. It can also encourage dead wood holding on for dear life, while more vital employees move on. If you accept or leave a position, be sure you understand whether your actions will cost you some of your retirement savings.

Charges

You’ll be faced with several types of charges. One is the plan administration charge: whatever the administrators charge to make investments, keep track of participants, distribute tax forms and make distributions. A few employers operate their own plans, but it’s increasingly common for the employer to contract this out to a third-party provider — Voya, Vanguard, Fidelity and others. You’ll pay a fee usually based on your amount of assets. The amount you pay is usually deducted from your contributions. As with all management fees, the difference between, say, 0.5% and 1.5% may not seem huge, but can make a big difference in the amount that stays invested over the years.

The second charge you’ll pay will be each fund’s own internal management fees, just as with any mutual fund. You won’t see these as a deduction. They’ll simply be taken out before any return is paid. Here again, lower fees over time gen­erally result in better returns.

If your plan offers load (commission) funds, or you have a self-directed brokerage account, you should find out what, if any, trading fees will be charged. Some plans may waive load fees, usually because their administrative fee will be high enough to cover it, but you’ll usually incur trading costs for individual investments. Be sure you know what they are.

Finally, some plans offer to assist you with an individual management service, usually also as a percent of assets invested. In every case I’ve reviewed, the “individualized” portfolio has closely resembled a target retirement fund, broken into individual fund investments. Rarely do they look at your entire investment picture or take into consideration any outside account. Don’t pay for these as a substitute for a little research on your part or independent financial advice.

Take Charge

Most employees, including the people in HR who select these plans and providers, have very little investment knowledge. They may go with the provider that offers the cheapest rates, not neces­sarily the best investment options. As a BetterInvesting reader, you have more expertise than most. If you ever have an opportunity to serve on a plan review committee or can advocate for the investment selections offered, please do so!
   
This article was originally published in the April 2020 issue of BetterInvesting Magazine.

D
anielle L. Schultz, CFP, CDFA, is a fee-only financial adviser with Haven Financial Solutions, Inc., based in Evanston, Ill. She can be reached at: www.HavenFinancialSolutions.com.
 

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