Many employees who save for retirement through an employer plan have ravaged their accounts in recent years. In fact, it’s the more mature workers – age 40 to 49 – who represent the largest group making withdrawals from their 401(k) plans. Among them, about half admit they’ve used these taxable withdrawals to pay current bills and debt; more than 12 percent say they’ve used 401(k) funds to pay for housing, according to a report on HelloWallet, an online financial guidance service.
That’s just one way 401(k) account balances have suffered in recent years. Another way is through fees paid to the very entities responsible for managing the assets for greater returns. According to the Financial Security Project at Boston College, the extra fees that investors pay money managers detract from fund performance – so much so that last year the U.S. Labor Department began requiring 401(k) plan sponsors to clearly disclose to plan participants how much they pay for the management of their retirement assets.
Over the past decade, 401(k) plan providers have wooed employers by setting up their plans for free. In fact, the cost is passed on to participants through investment and administrative fees. These fees can have a greater impact on returns than most investors realize. For example, say you have a 401(k) balance of $25,000 earning a 7 percent average annual return. If the fees you pay total 1.5 percent, the balance would be worth $163,000 after 35 years. However, if the fees total 0.5 percent, your investment would yield a 28 percent higher return ($227,000) during the same timeframe.
The new required disclosures should ultimately be a good thing to drive down costs for plan participants. This transparency behooves employers to take on more fiscal responsibility to negotiate lower fees with plan providers. If they don’t, employers may be subject to class action lawsuits. For example, in a 2010 case against ABB Inc. in Missouri, the employer was penalized for violating its fiduciary duties for its employee defined contribution plan. The company was ordered to pay $35.2 million in restitution and penalties. Because the employer did not effectively monitor and mediate the cost of its agreement with the plan provider, it was held accountable for excessive fees borne by the plan participants.
Beware Education Efforts
The good news is that because the pending retirement of 70 million baby boomers is top of mind for most of the nation, employers are taking a more active role in enhancing employee awareness of the problem. Some have started providing projections of retirement income distributions in the future based on the participant’s current account balance and contribution rate.
However, be aware that premature withdrawals and inevitable market corrections over time can significantly alter the accuracy of those projections.
401(k) Roth Option
The new American Taxpayer Relief Act of 2012 contains a little-known provision that allows employers to amend 401(k), 403(b) and 457(b) plans so that participants may convert pre-tax account balances to a Roth account option. While the Roth option is not offered in many defined contribution plans yet, the advantage it offers is that its assets – and whatever earnings they gain in the future – may be withdrawn tax free when you retire.
There are two things to note regarding the 401(k) Roth option. First, contributed assets do not get the tax deduction that other 401(k) deferral options receive. Second, if you convert assets from another 401(k) investment option, it’s technically considered a distribution and the amount will be subject to income taxes in the year converted. This influx of cash on your tax return could push you into a higher income bracket for the year, so you might want to consider converting over smaller portions at a time.
Whether you are close to retiring or not, it’s always a good idea to consult with a financial advisor about what you can do to better manage your plan for the future – and help prepare you for possible changes to 401(k) options.
