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Best Savings Strategies for Employees with Bad Retirement Plans

Best Savings Strategies for Employees with Bad Retirement Plans
June 28
01:34 2016

There’s been a lot of focus on things like “Tips for employees to determine if they have a bad 401k plan,” “Five (or whatever number) signs your 401k plan stinks,” “Who to talk to if you don’t like your 401k plan.” The unfortunate reality is, if the employee discovers their corporate retirement plan is below average, they can do very little to change it. Besides, what’s below average for one person may be just right for another. In many cases, it’s better to truly empower employees with practical alternatives should their 401k plan not measure up to their expectations. This, by definition, is the job of a good fiduciary (including the 401k plan sponsor, who can help employees turbo charge their retirement savings beyond what the company’s 401k can offer).

This solution, while seemingly obvious, often flies into the face of a much larger obstacle, one that even professional fiduciaries can find themselves stumbling over: The very definition of what it means for a plan to be “below average.”

How do employees usually discover their corporate retirement plans are below average?

We all know most employees pay more attention to what’s on their lunch menu than to what’s on their 401k investment many. Still, there exist very specific triggering events that nudge the employee towards taking a look at all those unopened 401k statements gathering dust on the far corner of the desk. “Employees will typically begin to discover their corporate retirement plan is below average in a couple of different ways,” Clint Bauch, President & CEO of Hausmann-Johnson Bauch Financial LLC in Madison Wisconsin. “The first occurs when the stock market goes through a correction employees tend to pay closer attention to their retirement plan. This can trigger a closer look at performance of the investment choices as well as fees being paid. The other time employees will discover a below average plan is when they review their personal retirement plan with their financial adviser and he/she may give an opinion on the quality of the corporate retirement plan. This can in turn cause employees to begin talking to each other about the quality of the plan.”

It turns out getting the employee’s attention is but a fraction of the problem. The bigger issue is what exactly does it mean to be “below average.” Doug Guillory, Retirement Plan Relationship Manager at Arista Financial Group in Alpharetta, GA, says, “As already mentioned, ‘below average’ is relative. Is it below average because their employer isn’t contributing enough as you’d like them to?  Not enough or underperforming investments? Excessive fees?  Or, is the employee simply not saving enough?”

Are Investments the problem?

Unfortunately, if you ask five different investment professional even the simplest of investment strategy questions, you’ll end up with at least six different answers. That’s because a very large component of any investment strategy is one’s investment philosophy. Too often employees – with the unwitting assistance of the professional – can confuse investment advice with investment philosophy. Since competing investment philosophies can lead to the same positive results (as long as one maintains a strict investment “discipline” – as if we haven’t thrown out enough jargon-packed words).

Confusing becomes more likely when you mix a sound principle (e.g., 404(c) safe harbor rules require a minimum of three distinct investment options) with a popular investment philosophy. For example, Neal Frankle, a financial planner at Wealth Resources Group in Los Angeles, California, suggests a “bad plan” exists when investment choices “are very limited or do not include index funds or ETF.” While complying with 404(c) does cover having a sufficient range of investment options, those options are not limited to a specific type of management style (in this case “index fund”) or investment product (in this case, “ETF”). While there are certainly advantages to certain styles and products, other styles and products offer their own unique advantages.

Keep in mind, however, that 404(c) only requires a minimum of three distinct investment options. An adequate plan is under no demand to provide every flavor of every investment style, philosophy, and product. In fact, there’s a solid argument suggesting plan sponsors have a fiduciary obligation to avoid doing this.

(see “How Many Investment Options Should 401k Plan Sponsors Offer?FiduciaryNews.com, October 18, 2011)

An astute plan sponsor, when asked about the lack of any particular investment option, can inform the employee the company plan is not meant to be the be-all-and-end-all to an individual’s retirement portfolio. It’s best when the retirement plan represents merely one color of the employee’s retirement palette. Matt Hylland with Hylland Capital Management in Virginia Beach, Virginia, says when a retirement plan has “a lack of options available for investment, such as no exposure to international equities. But usually this can be offset up investments in an outside account, such as an IRA.”

Fees

In recent years, fees have overtaken investments as the benchmark of choice among those assessing the relative merits of any particular 401k plan. Truth be told, it’s been a long time waiting for the light of day to shine on some of the more questionable fee practices. “401k plans have become much more transparent today thanks to increased disclosure requirements,” says Scott Stratton, President of Good Life Wealth Management in Dallas, Texas. “This means that many employees – especially at smaller employers – are discovering a lot of previously hidden expenses in their retirement plan.”

As with investments, what starts out as a good thing (i.e., finding hidden fees) can often find itself being taking over by an overly simplistic rule, even if one that is technically correct. Damon Gonzalez of Domestique Capital LLC in Plano, Texas, says, “Since 2012 employers have to send an annual notice to plan participants that discloses the fees for mutual funds in the plan. Don’t just throw it away. Look through the fees because even Morningstar has said that ‘The expense ratio is the most proven predictor of future fund returns. All things equal; by paying lower fees you get to keep more of your investments.’”

(see “A 401k Must Read: Mutual Fund Expense Ratio Myth BustedFiduciaryNews.com, October 9, 2012)

Better Benchmarks

As we narrow down our criteria, we also begin to focus on less subjective sources of data. “Employees can discover the strength of their plans by understanding the details of their employer plan by asking for the ‘SPD’ or ‘Summary Plan Description’,” says Mark Passacantando of Mark Passacantando Consulting in Boston, Massachusetts. “They can then benchmark their plan to other plans in their industry. There are certain online resources an employee can use to accomplish this.”

In addition, third party rating sources have begun to pop up in the last few years. Ted Jenkin, Co-CEO and Founder, XYGen Financial in Atlanta, Georgia, says, “The best place to go is to look at a ranking system such as Brightscope. This is a good place to get information on your 401k.” It’s important, however, to look into the methodology of any rating service to ensure they aren’t making some of the mistakes mentioned earlier.

Better benchmarks include plan design options such as matching formula, eligibility, and vesting. “Employees usually discover their retirement plans are below average if their plan does not offer a company match, does not offer a wide variety of funds to invest in, or if they do not have access to the retirement plan due to their employment status (full-time vs part-time vs length of service),” says Dr. Dominique Reese, Chief Financial Coach & Strategist at Reese Financial Services in Los Angeles, California.

Above all, it’s critical that employees keep the proper perspective when determining the merit of their company’s 401k plan. Again, here is where the plan sponsor might want to seize the initiative and remind employees what the limits and intentions of the plan are. It may be the employees bear more responsibility for their own satisfaction than the company does. “Most employees have the perception that their 401k is below average because their account balance isn’t where they want it to be,” says Guillory. “A 401k is an employee benefit. Just like health insurance, paid time off, and casual dress Fridays. If your employer offers a 401k plan, regardless of the costs, the employer match, the investment performance, etc., it will typically be better than not having a plan at all.”

Who would an employee talk to at their employer if they feel their plan is below average?

Employees can and often do find serious issues with their 401k plan. The most likely area of concern deals with hidden fees. It’s only been recently when plan sponsors have been able to see disclosures regarding the true nature of plan fees. Despite this mandate, there remain ways service providers can make it difficult for plan sponsors to discover the fee schedules that apply to plan assets. This is where a particularly diligent – and dedicated – employee can prove most helpful.

When an employee discovers something that needs to be reported, it’s useful for plan sponsors to make it clear who that employee needs to speak to. “Most companies have a ‘401k Administrator’,” says Passacantando. “While this person is usually in the HR Department, he/she may be in an operations role or management role.”

Who this person is can depend on the nature of the company. Gonzalez says, “It depends on the size of your company. If your company is small, you would probably speak with the owner. If you work for a large company, you should call your benefits or human resources department.”

For most employees, there will be a specific department assigned the task of following up on any plan issue. “Depending on the size of the company, and employee can begin with Human Resources,” says Bauch. “There is typically somebody within the HR group who will have insight on the corporate retirement plan. For smaller companies, an employee may have access to the owner or President and can directly have their questions answered. Employees ultimately may find their questions being answered by a financial adviser assigned to the plan or will be directed to a ‘1-800’ number to call the corporate retirement plan provider directly. As you can imagine, they will most likely spend time convincing the employee why their plan is NOT below average.”

Speaking with the correct person or group helps insure the matter is appropriately pursued. Stratton says, “Talk to your HR department, to the person managing employee benefits. They have an obligation to employees to act in your best interest in finding reasonable and appropriate fees for the company retirement plan.”

The employee, however, cannot expect change to occur instantaneously. Due diligence requires deliberation before any changes can be made. Jenkin says, “You should go to your benefits department or HR department, but be sure to come armed with facts because they typically only change the plans one per year or once every other year.”

On the downside, corporate departments aren’t the best at rocking the boat. Because of this, be prepared to petition other employees to support your efforts. Frankle says, when contacting the HR department, “don’t hold your breathe. They usually don’t understand that options are important. You’ll have to be patient, and maybe get other co-workers to voice their opinions as well.”

Reese says, “Employees at minimum can expect their employers to do absolutely nothing to address their concern. Depending on the size of the company, the employee’s influence may not reach far enough. In this case, galvanizing other employees to address the same concern can be useful. On the other hand, the employer may issue a survey to learn more about the employee’s concern and address the concerns accordingly.”

What can an employee reasonably expect their employ to do in response to their concerns?

Despite the skepticism of some, plan sponsors have several incentives to try to mollify employee concerns. Among them are regulatory considerations. “Employers should take employee concerns seriously,” says Passacantando. “The plans come under Department of Labor regulations. Administrators and management have a fiduciary standard of care imposed on them.  Accordingly, it is wise for management to address any and all concerns.”

Now more than ever, the regulatory environment has placed increased burdens on 401k plan sponsors. “Today’s increased fee transparency will put pressure on high cost plans to become more reasonable,” Stratton. “Often times the only way to get a lower fee is to switch providers, a process which takes months of research, due diligence, and preparation before implementing. Employees need to be patient and realistic about how long it may take for plans to improve.”

Making wholesale changes does take time, but there are other alternatives. “The plan is reviewed annually usually,” says Frankle. “The employer could change the plan but it is expensive, time consuming and risky. Better for the employer to lean on the plan provider to provide more choice.”

Even when the plan sponsor agrees with the employee, options may be limited. “If there is enough dissatisfaction, employers may feel compelled to find a better retirement plan,” says Stratton. “However, a company with 50 employees will never have access to the low cost plan that is offered at a company with 50,000 employees, where there are greater economies of scale.”

There are traditional systems both the plan sponsor and the employee can put in place to help speak to employee issues. Bauch says, “The employer should at a minimum be offering an annual group meeting to the employees where the recordkeeper comes in and offers a review of the plan and answers any questions the employees might have. Other helpful tools that the employer can offer are one-on one meetings with employees. The employee should inquire as to whether or not the plan has an investment committee and request what kind of process is in place to monitor the mutual funds being offered in the plan.”

Sometimes, although the plan sponsors listens sincerely, the employee may still not be satisfied. In a case like this, the employee has an option to turn to an objective party, who may be able to better explain matters to the employee. Guillory says, “Any good employer will listen and try to address them. If they have a financial advisor they work with, they are oftentimes good folks to discuss things with. Advisors are able to articulate the benefits from a different perspective that the employer would.”

A plan sponsor might be able to comfort the employee by making a single simple change to the plan. Employees, in turn, need to be aware of this possibility. Making a specific, albeit limited, request, could prove beneficial to both the plan sponsor and the employee. “The best thing you can do for yourself if you find out your plan is below average is to simply ask your benefits department to add a self-directed brokerage account,” says Jenkin says. The SDBA allows the participant to invest their money any way that they want and they will not be trapped with bad mutual funds.”

Ironically, it’s not unusual to discover the best way to improve a bad plan is to participate in it. Stratton says, “One last consideration: as the plan grows in size and gains assets, the company will have access to better plans and lower cost administration. Unfortunately, if no one participates in the current plan, it becomes less likely that the plan will be able improve in the future. Sometimes you may need to participate in a weak plan today so that things can be better in future years. Start-up plans are always going to be the most expensive, and unfortunately, that expense is going to be borne by the participants.”

When employees have run out of option, there remains one last desperate alternative. “There have been a lot of lawsuits where employees have successfully sued their employers for breaching their fiduciary duty,” says Gonzalez. “I find that many HR people or owners don’t understand their fiduciary duty and don’t even know their 401k plan is packed with fees and there is an advisor getting paid a lot of money for doing very little for the plan each year. It is a sensitive subject, but I would suggest that you ask to see if the company can get some new quotes to see if there is a better plan available. Sometimes companies start out with an expensive start up plan with no assets and the plan grows where they can move it to a better and more economical plan.”

What alternatives retirement savings strategies outside of their company plan might employees take advantage of?

Consider Using a Spouse’s 401k

It always helps to think outside the box. In this case, employees should think outside their own 401k and consider their spouses 401k. “If your spouse has access to a great retirement plan, maximize that contribution,” says Stratton. “In other words, put $18,000 into the ‘great’ 401k may be a better option than putting $9,000 into two plans if one is truly a bad 401k. If you are not sure of what options are available to you, hire a fiduciary – someone who is required to place your interests ahead of their own – and not a salesperson.”

No Matter How Bad the 401k Plan, Remember, the Company Match is Always Free Money

When a company offers to match an employee contribution, the employee should recognize that free money. Bauch says, “First, keep in mind that even if the plan appears to be below average, if the company offers any type of match to the employee’s contribution, they should generally contribute up to that matching formula.”

Gonzalez agrees. He says, “If your employer will not shop for a better plan, you could consider saving some money to your own traditional IRA. If your employer offers a match you want to make sure that you are contributing enough to get it. If the match is 50 cents on the dollar up to 6%, you are making a 50% return on that first 6%. You want to get that match even if you hate the plan. Once you are getting the match, you may be able to make a pre-tax contribution into an IRA where you could invest in almost anything. Keep in mind there are income limits if you are considered an active participant in a retirement plan and you may not be able to deduct your IRA contribution. You will want to look at box 13 on your W2 and then read IRS Publication 590 or speak with a tax advisor to see if you are able to deduct your IRA.”

This bears repeating. It’s important for employees to inform the plan sponsor if they find a problem with the plan. It’s not wise, however, to throw the baby out with the bathwater and “vote with your feet” and leave the plan. “Employees should have speak up when their retirement plan is too expensive, has poor options, or conflicts of interest,” says Stratton. “However, don’t shoot yourself in the foot by not participating. If the company offers a match, that is free money, an immediate 100% return on your contribution. I have yet to see a plan that is so bad that you would not want to participate up to the level of the match. Most employees today are going to have many jobs over their career. Reducing your retirement saving because of a bad plan is going to hurt you in the long run. The most likely scenario is that you will be with that employer for 5-10 years and then move on to another job, at which time you can roll your 401k out of the bad plan and into an IRA or to your new 401k, if it is better. Most likely, you aren’t going to be stuck in that bad plan for life. And if you are close to retirement, yes, still contribute to a ‘bad plan’ because your main focus should be on growing your nest egg and gathering assets. At retirement, roll it over to an IRA.”

When all Else Fails, Turn to IRA Options

Beyond the match, if an employee wants an alternative to participating in the company’s 401k plan, there are options. “If the employee really does not like the 401k plan, they can do a self-directed IRA,” says Curtis Chambers, a financial advisor in Largo, Florida. “That way, they’ll have complete control. The disadvantage is the contribution limits for IRAs are lower.”

When considering the IRA option, Frankle is both “yes and no.” He says “you can always fund an IRA – but it’s only fully deductible if you earn less than $61k (single tax payers) or $98k (married filing jointly) under 2016 tax law.”

In addition to eligibility restrictions, there are also contribution limitations. “A traditional IRA has the same tax treatment as a typical 401k, but has a much lower contribution limit and the tax benefits may be limited based on your income,” says Hylland. “But an IRA can provide at least $5,500 per year in tax advantages.”

There are many retirement savings options outside company 401k plans. Bauch says, “Employees can look outside the plan to things such as: IRAs, Roth IRAs, and even non-retirement (investment) accounts. Whether or not these are appropriate alternatives will depend upon a variety of factors including their overall goals, time horizon, risk tolerance and tax bracket.”

The key consideration is to consider all the possibilities within the total context of the individual. “I suggest employees think first and foremost about their own financial goals,” says Stratton. “As a rule of thumb, people should save 10% of their income for retirement. Some will need to save more if they’re getting a late start, but having a below average company retirement plan doesn’t change your need to save. After you contribute up to the match, consider other options: Are you eligible to make a deductible Traditional IRA contribution? How about a Roth or SEP IRA? All of these have income restrictions and other requirements, so plan carefully and know your eligibility before you stop contributing to a company plan.”

Don’t Forget Taxable Alternatives

Lastly, not all retirement savings options include retirement vehicles. Stratton says, “People should also consider investing in a regular taxable account for retirement. While you won’t get an upfront tax-deduction, you will be eligible for long-term capital gains treatment. For most investors, that means paying only 15%, whereas a retiree who withdraws from their 401k or IRA will pay ordinary income tax, which could be 25% to 39.6% or more. Because most Americans have only invested inside of their retirement plan, many forget that we can also invest outside of a retirement plan. While you lose some tax benefits, surely investing in a taxable account is better than not investing at all!”

In the End, Who’s Responsible for Your Retirement?

With all the talk of guiding employees to determine if their 401k plan is any good, it’s important not to lose sight of who’s ultimately responsibility for retirement saving. “Participants must take more control over their retirement,” Guillory. “Save as much as you can and always take full advantage of any employer matching contributions.  Understand the investments offered and use proper diversification strategies. The alternative is you could simply choose not to participate and do it all by yourself.”

Are you interested in discovering more about issues confronting 401k fiduciaries? If you buy Mr. Carosa’s book 401(k) Fiduciary Solutions, you’ll have at your fingertips a valuable reference covering the wide spectrum of How-To’s (including information on the new wave of plan designs) every 401k plan sponsor and service provider wants and needs to know. Alternatively, would you like to help plan participants create better savings strategies? You can buy Mr. Carosa’s latest book Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort right now at your favorite on-line or neighborhood book store.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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