Money Magazine Ask the Mole

How to deal with a bad 401(k) plan

In a 401(k) plan, you're limited to the investment choices that your company offers. So what if they're not so great?

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By the Mole, Money Magazine's undercover financial planner

the_mole_illustration.03.jpg
Have future topics for the Mole to address? E-mail him at themole@moneymail.com.
SUBMIT

NEW YORK (Money) -- Question: Both my husband and I have 401(k)s that are annuities backed by mutual funds. The returns, compared to our rollover IRAs in Fidelity funds, are unimpressive. What is the best strategy for dealing with a lousy 401(k)?

The Mole's Answer: Unfortunately, I see this far too often in my practice. Let me explain why so many companies offer lousy 401(k) plans, and then I'll give you some practical advice on moving forward.

It's relatively expensive for an employer to have a 401(k) plan administered. There is quite a bit of record keeping and compliance issues involved. But many custodians will offer these services to employers for little or no cost - to the employer, that is.

The 401(k) providers don't actually care how they make money, just as long as they make a tidy profit. That's why so many providers offer the employer low-cost plans and make up the difference by offering the employees very expensive mutual fund options. These 401(k) providers make a bundle off of the really lousy choices they offer the employees.

Smaller employers especially can't afford to pay the hefty administrative fees associated with these plans and I've seen plans that average fees of 2% - 3% annually. Highway robbery, if you ask me.

A plan like yours that offers annuities within a 401(k) is actually making you pay for the needless tax-deferral within a tax-deferred account. In essence, it's like wearing a raincoat inside your house. I've seen annuity offerings more often within the not-for-profit 403(b) plans, but they can be offered in 401(k) plans as well, as is the case with yours.

My first piece of advice is to start with your employer. This is contingent upon having the right relationship with your employer and bringing the matter up to the owner or the human resources department. I've found that many employers have no idea that they've provided their employees with such lame options. Once they know, they may be willing to make some changes.

If the employer changing 401(k) providers isn't an option, here are some practical tips:

Never miss out on the employer match. I've seen some pretty pathetic 401(k) plans, but I've never seen one so bad where it made sense to pass on the free money the employer is willing to shell out via a partial matching of the employee's contribution.

Look into IRAs. Once you've contributed to the employer's matching level, see if you are eligible for an IRA contribution. If so, you can contribute $5,000 this year ($6,000 if you are 50 or older) and put these funds in lower-cost, more diversified options that you can find at providers like Fidelity or Vanguard.

Consider bonds. Hopefully your 401(k) account is only part of your nest egg. Build your total portfolio using your 401(k) as part of your retirement and look at your entire asset allocation. Bonds are usually best suited for your tax-deferred account, as where you locate your assets is critical. Sometimes you can find a bond fund in your offerings that is less outrageously expensive than the stock funds.

Favor index funds. If you are buying an equity fund, see if your plan offers some kind of index fund. Often an S&P 500 index fund with an expense ratio of 1.00% or more is still better than an active fund with a 2.00% expense ratio. I don't like holding just the largest 500 domestic companies, and prefer to own the total stock market. But if you need to, you can go outside your plan to buy a fund like the Vanguard Extended Market Index fund (VEXMX). This owns all U.S. stocks except the S&P 500 so it works as a great supplement to an S&P 500 fund. Buying about $1 for every $4 you have in an S&P 500 fund will approximate the total U.S. stock market.

Opt for a rollover. Roll out these funds to an IRA the minute you leave your employer. That's the only way to get out of these really lousy selections. Make sure you do a direct rollover so you don't inadvertently create a taxable event.

For more information on what to do when you are captive to a lousy retirement plan, I suggest you read Dan Solin's, "The Smartest 401(k) Book You'll Ever Read."

Short of quitting your job, the only strategy is to minimize the negative impact a lousy 401(k) plan will have on your nest egg. Keep the damage to a minimum while you are at this employer and then run for the hills as soon as you leave.

The Mole is a certified financial planner and certified public accountant who - in the interest of fairness - thinks you should know what goes on behind the scenes in financial planning. Want to make contact? E-mail themole@moneymail.com.  To top of page

Send feedback to Money Magazine
Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
Want to buy -- and live in -- a piece of history? It's not that far out of reach. These historic homes are not only for sale, they are incredible bargains. More
5 ways retailers are tracking you If you think pesky salespeople are invading your personal space, check out these 5 technologies that are tracking your movements throughout a store. More
Moto X vs. Droid Turbo: Which Droid should you buy? Motorola has made the two best Android smartphones this year. Here's how they stack up. More


Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.