In another blog post I explained some of the more common mysteries surrounding your 401k plan. Here are more things you might not know (but should!).
It’s not free
This is one of those things that, when someone says it, you think of course it’s not free. However, do you know how much participating in the 401k is costing you? Or that depending on the investment you choose, your fees will be different?
With a 401k plan, there are two main types of fees. One you can do something about on your own, the other is much harder to change. The hardest to move is the fee that your company negotiated for the plan provider to manage your 401k plan. I’ve seen articles that estimate this can be from as low as .25% to well over 1.5%, often corresponding to the size of your company. You can research this fee with your HR department. They should have compared fees with other companies of the same size to make sure plan provider fees are in line. If they haven’t, put a bug in their ears.
Whether or not the plan provider fee is in line, there’s one fee you can take care of on your own. It’s the fee charged by the investment company for the fund you’re invested in. Actively managed funds generally have higher fees than index funds or exchange traded funds. Most plans provide a range of funds (stock, bond, money market), but some provide both actively managed and index funds of the same class, from which you can formulate an investment strategy with the fees you want. Take a minute to look at the funds you’ve chosen to see if there are other similar options in the plan that have lower fees.
Remember though – the key is to invest your money so you have the best chance of achieving your retirement goals. Don’t pick a fund based solely on the fee. You need to determine your asset allocation for your 401k plan, then choose active, index, exchange traded or a combination of funds to achieve that while also keeping an eye on fees.
Getting your money may cost you
I almost didn’t put this in here, because I’ve heard people say they don’t want to tie up their money for 40 years. What if I need it? And while that’s a valid point, not investing (and giving up any free money your plan offers) isn’t going to move you toward a more secure retirement. You have to be vigilant when you’re contributing to your 401k. If things are going well, you can put it on automatic pilot. But if there’s a rumor of layoffs and you’re living paycheck to paycheck, it may be time to consider lowering your 401k contributions until you have some savings built up. Why? Because getting your money out of the 401k may cost you.
In most cases, if you withdraw money before you’re 59½, (and yes, that’s the official age), you will pay federal income tax on the money plus a 10% penalty (and any relevant state income tax). Not only will this cause a severe reduction in the money you’re withdrawing, but any withdrawal also reduces your remaining nest egg in the plan so there’s less to grow for the future.
Your plan may have provisions for hardship or other withdrawals that allow you to withdraw money without the 10% penalty. However, the tax burden would still apply. There’s a loan option in some plans, but again you’re reducing your nest egg and compound earning potential. (Read through your plan documents or talk to HR to learn more.)
There’s even a stipulation allowing you to take equal payments from your 401k plan at any age. At age 59½ you can start taking money out, and at age 70½ you must take required minimum distributions. But at any age you could take equal payments from your 401k plan if your plan allows. The payment amount is based on a calculation that takes into account your age and your 401k balance. Chances are, if you’re young and have a small amount in your account the equal payments will be tiny though.
All retirement plans aren’t the same
Depending on your company, you may be enrolled in a 401k or a 403b plan. The easiest way to distinguish between the two is 403b plans are available to nonprofit organizations and government workers while 401k plans are offered by for-profit companies. I had mistakenly thought this was the only difference.
So you can imagine my amazement when I discovered my wife was automatically enrolled in her employer’s 403b plan. Yep, no questions, no signup form, no meeting, no nothing. And here’s the kicker: she can’t opt-out of the plan. From what I’ve read, 401k plans provide an opt-out opportunity for participants while that’s not a requirement of 403b plans.
There are other differences. 401k plans are usually run by mutual fund companies while 403b plans may be run by insurance companies. 401k plans historically have had higher match rates than 403b plans. And there are various reporting differences.
Whatever plan you’re in, be sure to read the minute details of the plan, including investment option information and fees, withdrawals allowed and their costs, etc. Your HR Department should have the Summary Plan Description or other official document that goes into a lot more detail than the glossy brochures you might have received. It’s your money – make sure you’re educated on what’s happening to it.
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