Should You Invest in a Lousy 401(k)?

Question: I've just started a new job and have heard several of my coworkers complaining about how bad our 401(k) plan is. Should I skip it and invest in a Roth IRA instead?

Answer: All 401(k) plans offer tax-deferred compounding and the ability to make contributions on a regular schedule, both of which can be important benefits for long-term savers. But before you jump into a 401(k) with both feet, you're smart to consider whether your company retirement plan is the best receptacle for your money. If it's not up to snuff, you're better off contributing just enough to earn matching contributions, then move over to an IRA for additional retirement savings.

Here are the key questions to ask as you assess your 401(k) plan's worthiness.

1. Are You Earning a Match?
To see if your employer matches any portion of your contributions, get your mitts on your employee handbook or a document called a Summary Plan Description. If you're getting a match, you'll want to contribute at least that percentage of your salary to your plan. Most employers match 50% or 100% of at least a portion of their employees' contributions, and you'd be hard-pressed to earn anything close to that kind of return by investing outside of your plan.

2. How Costly Is the Plan Overall?
Before you invest more than the amount needed to maximize your matching contributions, check to see whether your plan is charging an extra layer of fees to cover administrative expenses. Employees at big companies may not have to pay this layer of expenses because their size has enabled them to negotiate good deals with investment providers. But employees of smaller firms may not be so lucky.

Again, look to the Summary Plan Description for a view of how much you're paying for the convenience of being in the 401(k) plan. (This number may also be found in your plan's annual report, often called Form 5500.) If administrative costs are higher than 0.5% per year, that's a red flag that your plan is costly.

3. How Good Are the Investment Options?
If you're earning a match and you're not paying an additional layer of administrative expenses, those are good signs that your plan is solid. But you also need to conduct some research on the quality of the investment options.

If your plan holds mutual funds, you can find detailed information about them by entering their tickers on Morningstar.com (use the Quote box at the top of this page).

Focus on the following data points:

Expense Ratio: Make sure you find an exact match for the fund share classes that are in your plan; for example, if your fund name is followed by an R1, look at data for an identical share class on Morningstar.com. If your plan's investments are appreciably higher than the thresholds below, that's another red flag that your plan is pricey.

U.S. stock funds: Less than 1.25%Bond funds: Less than 0.75%Foreign stock funds: Less than 1.5%Manager Start Date: Also check how long the managers have been running the fund. When selecting mutual funds, there's rarely a good reason to settle for a newbie manager. Look for manager tenures of five years at a minimum.

Returns Relative to Category: Returns aren't the be-all and end-all of fund selection, but they are one of the only quantifiable measures of how a fund has delivered for its shareholders in the past. Check out a fund's five- and 10-year return ranking versus its category peers. (Lower numbers are better here.) Not every fund in your plan has to be at the top of the charts, but look for a good number of funds whose returns land in the category's top half or better.

4. Is There a Roth Feature?
If you're just starting out in your career, or even if you're not, the ability to make Roth 401(k) contributions can be an extremely desirable benefit. You'll pay taxes on Roth contributions, but you'll be able to take tax-free withdrawals--a key benefit if your future tax rate is higher than your current one. Read this article http://news.morningstar.com/articlenet/article.aspx?id=263104 to assess whether a Roth makes sense for you. If it does and your plan doesn't have a Roth feature, you may be better off funding a Roth IRA before putting money into a traditional 401(k).

5. Are You Maxing Out Your IRA Options?
Are you a high-income earner who is already maxing out other tax-sheltered options such as IRAs? If so, that argues for contributing the maximum to your 401(k), even if you don't particularly like the investment options and/or you're not earning a match. Contribution limits are much higher for 401(k)s than IRAs, allowing you to shelter more of your investment income from taxes. Those tax savings can be valuable if you're in a high tax bracket, even if the individual options in your plan are only so-so.