The Worst 401(k) Mistake


In my opinion, the worst 401(k) mistake is the failure to focus on employee outcomes. The “outcome” should be for employees to have enough money to retire with confidence and financial security.

To help employees get there, employers need to ask the right questions. For example, are employees participating in the plan? Are they saving enough to retire with financial security? Are they investing properly? Do employees know how much it costs to retire, so that they will have an adequate income for 20 years or more?

Those are critical questions. Yet, for most 401(k) plans, those questions are unanswered.

Let’s start with some background. 401(k) plans were created to be savings plans, not retirement plans. The purpose was to allow employees to save money that could enhance their retirement, but 401(k) plans were not intended to be the primary vehicle for retirement; they were intended to supplement defined benefit plans. That is no longer the case. 401(k) plans are now the main retirement plan for most employees.

In some ways, it’s unfortunate that 401(k) plans became popular in the 80s and 90s, when the stock market was booming. Because of that timing, many employees hoped for outsized investment returns to generate the money for a comfortable retirement. However, the stock market crashes of the early 2000s and 2007-2009 dashed those hopes

More recently, the focus of plan fiduciaries, often the members of a committee appointed by the employer to oversee the plan, has been on the costs of the plan’s investments—because fiduciaries have been sued for choosing overly expensive mutual funds.

Because of these historical developments, much of the attention of fiduciaries and employers has been on “funds and fees.” When I attend 401(k) committee meetings, most of the time is spent on the quality of the investments and a fair amount of time is spent on the expenses of the investments. However, very little time is spent on plan success . . . whether employees are on course to have enough money to retire.

This needs to change. The focus needs to be on the real-world role of 401(k) plans to enable employees to retire.

However, the law does not require employers to look at retirement outcomes. Employers and committee members can be sued for picking mediocre or overly expensive investments. But, they can’t be sued because employees don’t have enough money for retirement.

In other words, the focus on retirement benefits, rather than funds and fees, is a best practice. That means employers aren’t legally required to help employees improve savings and outcomes. But, there is more to life than satisfying the law’s minimal requirements . . . there are best practices of going above and beyond what the law requires. It’s the right thing to do.

What can employers do to improve the success of their plans? The answer is easy . . . tell their advisers, consultants and providers that they want to measure the outcomes of the plan and compare them to other similar companies. That’s called benchmarking. Once a company has benchmarked its plan against other similar companies, it can see if its employees are worse or better off than those at other companies. If their employees are not doing as well, then the employer should ask its advisers and providers for ideas about improving the outcomes. There are all kinds of solutions, and 401(k) specialists know what they are. The key is to ask.

What if a plan is benchmarked and it is doing better than the plans of the employer’s competitors? That’s good news. The employer and the committee members should take pride in those results. However, as good as the results may be, they can always be better. Even there, advisers and providers know the tools for improving plan success. A best practice is for the plan sponsor to ask for help, consider the answers, and then act.

What can employees do? Employees should benchmark themselves. That can be done through retirement income projections. If a plan doesn’t already offer those, employees should ask if the plan’s provider can generate that information. Once an employee receives personalized retirement income projections, he or she should compare that to a benchmark for adequate retirement income. Most experts recommend something around 70% of pay as a reasonable level for living in retirement. That takes into account social security, benefits from the retirement plan, and personal savings.

As with retirement income projections, many plan providers can offer individual benchmarks and “gap analysis.” What is “gap analysis?” That is a service that tells employees whether they are on course or not and, if not, how much more they need to save out of each paycheck. If your plan doesn’t provide gap analysis, ask your employer if the plan’s provider can add that service.

No matter what an employer does, though, most of the burden is on the employees. Good investments and low costs are helpful, but employee contributions are the driving force for retirement results.

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