401(k) Weren't Made to Carry the Weight of Your Future
Most employees refer to their 401(k) as their “retirement plan,” but unless you start early, putting away a good chunk of your own income, you may fall short of building your retirement nest egg.
401(k) plans started out as a source of extra cash for individuals who were already guaranteed a secure monthly retirement income through pension plans. These retirement plans were funded by the employer and are known as “defined benefit” plans. This was the common retirement plan offered by most companies when your parents entered the workforce.
The double-digit interest rates of the early 1980s made it relatively easy for companies to fund pensions with low-risk bonds, but when interest rates began to fall pensions became more expensive for companies. As more and more companies decided that pensions were too pricey to continue, 401(k) plans continued to grow.
401(k) plans are known in the industry as “defined contribution” plans because the financial burden is placed squarely on you, the employee, to make your own “contributions.”
In 2008, only 7% of private sector employees with retirement benefits had a pension, down from 62% in 1980. As a 20- or 30-something-year-old employee, by necessity, you are taking on a much larger burden of saving for your retirement.
How Do You Know if You Are You Saving Enough?
When it comes to actually figuring out how much to save to live a comfortable retirement, most workers are on their own. Employers may offer online tools to help participants prepare their own retirement income projections, but few workers have enthusiastically embraced the challenge of doing these themselves.
Most people vastly underestimate how much money it takes to have a lifetime income. The average employee contributes 6.4% of her paycheck to her 401(k), according to the Plan Sponsor Council of America. However, financial advisers recommend 10% as a baseline minimum, and for those who start late (in their 30s-40s), 15%.
Fee Transparency? What Fee Transparency?
New Department of Labor regulations went into effect this year requiring plan providers to disclose the amount in fees that both companies and their workers’ pay for their 401(k) plans. The intention was to shed light on notoriously murky 401(k) fees. It’s one of the few instances where the consumer of the product—both employers and employees alike—often have little idea what they’re paying for, thanks to buried fees.
Under the new disclosure rules, statements will itemize fees deducted from their plan. But critics have been disappointed with the first round. Some statements “disclosed” a wide range of fees, as in “your expenses range from 0.25% to 2%.” Those small percentage differences may not sound like much BUT…
…you’re losing years’ worth of savings to fees.
Let’s look, for example, at a fund with a 1% fee. When it’s chipped annually from your retirement nest egg, the cumulative effect can be significant.
Take a worker who makes $75,000 per year and saves 8% of that annually. Over the course of a career, he or she would lose almost twelve years’ worth of savings in a fund with a 1% fee.
The brokers who advise companies on plans often don’t have an incentive to choose the lowest-cost option, since they get compensated through commissions paid out by investment firms for pricier share classes. Companies and individuals often don’t realize this and think their broker’s advice is “free,” since the compensation fee is bundled into the expense ratio, even under the new DOL fee disclosures.