This week while talking with a prospective client I was reminded of an article I wrote several years ago that outlined the Do’s and Don’ts when it comes to your 401k/403b investment plans. I thought it would be good for you to learn some of the things I’ve seen in my 32 years in this business with these plans.
I’ve witnessed it time and time again: A family comes in to get our Retirement 360 Game Plan (which is an analysis that breaks down a portfolio) and we find that they have invested a large amount of their retirement plan in the company stock.
This is a BIG no-no!
Look at Enron, General Electric, Ford, Motorola, Kodak and the list goes on. I realize as an employee sometimes it’s easier to invest in the company store. You know the product, you see the successes and issues first hand, but it can be devastating if it all goes wrong. In Louisville, Kentucky we meet with a lot of folks who work for UPS. Typically, these are great hard-working folks that simply want to earn a paycheck and retire someday. And to UPS’s credit, they have a very strong package of benefits. But it is not uncommon to have one of their employees come in and have 75% to even 100% of their retirement invested in the company stock. All it takes is one bad earnings report, or GOD forbid an accident in one of those planes and it could mean another 10-15 years working.
My rule of thumb, no more than 25% in the company stock. There are usually multiple options you can choose from to invest the other 75%.
Most of the plans have fixed it so you can’t do this anymore (day trade), however, some plans still allow you to trade the account daily. This can be a mistake! With computerized trading algorithms in charge of most of the institutional accounts, you’re simply not going to beat them.
My advice is stick to the low-cost Index Funds your plan offers. Diversify across asset classes and let it ride. Or use a monitoring service, (see our 401k Optimizer or other type services.)
These services will build a portfolio from your choices based on your specific risk tolerance. Then they will watch your model and send you a notification if it needs to be changed. Typically, they will charge you a small fee, but in my opinion, it’s worth it. For most, this is the largest asset you have, outside of your home, so you need to protect it ESPECIALLY as you get closer to retirement.
I used to think this was common sense, however, the 401k Companies make it entirely too easy to borrow money from your future. Let’s think about the process. First, you are adding dollars to your plan on a pre-tax basis. The money comes out of your pay before any taxes are applied to your check. The money then goes to your plan to be invested. You get in a tight spot and need some cash, they offer to allow you to borrow the funds at a very low-interest rate. Then they tell you the interest you are paying, is really going back to you. While the money is borrowed, you pay NO taxes on it and if you pay it back on time, there is no penalty.
So, what’s so wrong with that, you ask?
The normal process to pay these loans back is just like any other loan. You write a check and mail it in. Typically, the contributions have to stop while you have the money loaned out, and if not, they do not allow the contributions to pay back the loan. So, you’ve borrowed money from your Tax-Deferred account, you are paying it back with after-tax dollars and when you take it out in retirement you get to pay taxes on it again! Not a good strategy! Figure out some other way to get money when you need it, don’t borrow from these plans.
Last week, I brought on a new client who owns a company in a nearby city and plans to retire in the next couple years. We moved about $500,000 of his new plan, but he still has $1.7 million invested in the old company plan. He doesn’t want to move that until he retires.
During our routine discovery process, I found that his bigger plan had a different beneficiary than the one we just added to his new account. I asked Jim if there was some sort of agreement with an ex-wife, but he said there wasn’t. Come to find out, when he divorced over 20 years ago, he never changed the beneficiary on that plan. So, his ex-wife was in line to receive 100% of the $1.7 million-dollar account, and his current wife would be left out completely. Worst yet, she wouldn’t have a leg to stand on in court.
Beneficiary designations trump all cards. That is why you must check these plans to make sure nothing is missed.
Again, I would think this would be common sense, but it’s not. You should never leave your plan with the company when you leave or retire. Most 401k plans have limited choices for investing, they are owned by the company (not you) and they typically have excessive fees attached to the plans.
I know, I hear it all the time, “My company pays all the fees in our plan.” Really? Do you really believe your company is paying all those fees? Well let me tell you, they are not! The national average on these plans is over 3% in fees per year. These fees will drastically reduce the longevity of your plan.
The plans normally have few choices. So, to truly have a diversified plan, you need to transfer it to an IRA. Here you can control the cost and provide yourself a better selection of funds.
Lastly, these plans are owned by the company. Yes, the money in them is yours, but if the company decides to change a plan, they can do so without any approval from you. I’ll give you a for instance, let’s say you have a nice low-cost plan with Vanguard. You’re happy the company allowed you to keep the plan after you retired. Then the company decides to change it to a plan with Principal or Voya (much more expensive plans). You are out of luck! Your plan must change and during the process, you may have limited access to your money.
My advice is to take your plan with you when you leave. It’s easy to do and can save you a lot of hassle in the future. Learn more about rollovers here.