Photo credit: jb
Okay, the title might be a little misleading in regards to how I really feel about 401(k) plans… I do think that these plans are (or can be) good for a lot of folks, as long as they use them correctly and follow sound investing principles. But that’s not what this post is all about.
The 401(k) plan is one of the places that the average Joe Employee is not well-served – in ways you don’t realize.
The 401(k) Dirty Little Secrets
Without getting too technical about all this, one problem is that most 401(k) providers are able to get away with supplying a plan that is high in cost when compared to the rest of the marketplace, with no one but the plan participants (read that “employees”) bearing the brunt of the cost. And furthermore, the plan participants have little to no say in making changes to the plan in their favor.
It doesn’t have to be as nefarious as the employer choosing to stick the employees with high fees – it likely is a given fact that costs are higher for smaller employers’ retirement plans because they can’t achieve an economy of scale to keep costs low.
At any rate, most individuals can do much better (cost-wise) than 401(k) plans by looking to the low-cost alternative investing options, such as no load mutual fund companies and low-cost brokerages.
Since there is no legislation to make true fiduciary responsibility a requirement – meaning that the plan provider must act in the best interests of the plan participants – most often the plan and the investment choices are among the highest internal cost investing options available. And because the fees are charged totally at the back end (at the mutual fund company, usually) and the employer sees little or no up-front costs, the employer is happy with the plan.
In addition, the mutual fund company is thrilled to have a captive audience with only their funds available to be invested in – which translates into new deposits for the company for nearly zero marketing cost. Of course the agent who sold the plan is ecstatic: for virtually no ongoing effort, he is able to rake in a percentage from each and every dollar that goes into the plan.
On top of the higher costs and limited choices, 401(k) plans are the most restrictive of all contribution-oriented retirement savings options available. Typically, the only way you can touch the money in the plan is to leave employment at the company. 401(k) plans, as a concession, do allow loans against a portion of the holdings, which is unheard of for IRA plans.