A good 401(k) plan can boost your chances of a secure retirement and perhaps even allow you to retire sooner--if you take advantage of it. A generous employer contribution and low-cost investment options coupled with the tax deferral will help your savings grow. Conversely, an expensive 401(k) plan with poor investment choices will make it more difficult to save for retirement. Here's how to tell if your company has a competitive 401(k) plan:
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A generous 401(k) match will help you grow your nest egg quicker. The median employer 401(k) contribution was 3 percent of a participant's pay in 2009. But 401(k) matches ranged from less than 1 percent to more than 10 percent of salary and were matched according to more than 200 different formulas, a recent analysis of 2,200 retirement accounts with more than 3 million participants administered by Vanguard found. Plans also differ greatly in the amount workers must save to receive the entire match. The median 401(k) plan requires employees to save 6 percent of pay to maximize their 401(k) match. Some employers don't offer a match at all, or reduce or eliminate contributions in years when the company performs poorly.
You can't always begin participating in a company's 401(k) plan as soon as you are hired. Only about half (51 percent) of employers allow workers to contribute to the 401(k) immediately upon joining the firm, Vanguard found. Other companies require between one and three months (25 percent) or even an entire year (15 percent) of service before employees are permitted to participate in the retirement plan. "If you change jobs seven times in your lifetime, and every time you change jobs you have to wait a year, you are basically wiping out seven years' worth of contributions," says Matthew Hutcheson, an independent fiduciary and pension consultant. After qualifying to participate in the plan, most employees have to wait even longer to qualify for the 401(k) match. Just 40 percent of companies immediately provide a 401(k) matching contribution to employees who save for retirement. And more than a quarter (28 percent) of companies don't contribute to retirement accounts until a worker has spent a full year at the company.
Many workers don't get to keep their 401(k) match until it is vested. Just over a third (37 percent) of employers allow workers to keep the 401(k) match as soon as it is deposited, according to a 2008 Profit Sharing/401k Council of America survey. Other companies require you to stay with the company for several years before you can keep the match or allow you to keep only a percentage of the match based on job tenure. "In general, you should be fully vested within six years," says Marcia Wagner, founder and principal of Wagner Law Group in Boston. Retirement accounts with no or short vesting schedules are generally the best deal for employees who think they might stay with the company for less than six years. Those who leave the company before they are vested forfeit some or all of the 401(k) match.
Most 401(k) plans offer a limited range of investment options. In 2009, the average 401(k) plan offered 25 investment options including equities, bond funds, balanced or lifecycle funds, and money market or stable value options, up from 15 options at the beginning of the decade, Vanguard found. But most participants (61 percent) used three or fewer of those options. "Most 401(k) plans brag about how many choices they give to people," says Dan Solin, senior vice president of Index Funds Advisors and author of The Smartest 401(k) Book You'll Ever Read. "The problem is that very few people are capable of putting together a globally diversified portfolio and an asset allocation that makes sense for them." He says a good 401(k) plan includes at least three low-cost index funds, ETFs, or passively managed funds, and at least one target-date or lifecycle fund. Ideally, your employer would also provide easy-to-understand information about the expenses associated with each investment option
Beginning on July 16, 2011, 401(k) service providers will be required to disclose the fees and charges deducted from 401(k)'s. Until then, ask for a copy of each fund's prospectus and pay particular attention to the funds' expense ratios. Look for funds with an expense ratio below 1 percent, especially when it comes to index funds, ETFs, and passively managed funds, Solin says. "If all the expenses for your 401(k) are more than 1.5 percent, that is starting to look like it is really going to eat into your returns."
Responses to Employee Needs
Employers use 401(k)'s to attract and retain productive workers. If you're not happy with your 401(k) plan, consider suggesting changes to your human resources department. "Ask your employer to consider making enhancements to the plan and suggest one or two--or no more than three--things," says Hutcheson. "Show the employer how the change would impact how much you have at retirement. I have found time and time again that very seldom does an employer say no to that."