Do you ever wonder whether your client's 401(k) plan is as good as management says it is?
Over my 30-year career, I have worked with many 401(k) plans from Apple and IBM to John Deere and Mazda Motor Corporation. I have consulted with a number of great Fortune 500 companies on their retirement plans, as well as with hundreds of excellent small- and medium-sized companies.
How can employees tell if their employer's 401(k) plan is a good one? In my experience, the best plans always possess the following attributes:
1. Availability of index investment options
Index mutual funds, such as the Vanguard 500 Index Fund, allow employees to invest in their 401(k) plans in a cost-efficient way. The best 401(k) plans offer a number of index fund options over the entire asset class spectrum. For example, index options should be available in at least the fixed income, U.S. equity and international equity asset classes.
Better 401(k) plans will have at least one fixed income index option, three U.S. equity index options and one international equity index option.
2. A cost-efficient target date series
If your clients are like most workers, they may find it easier to invest in a 401(k) plan using a target date fund. These funds are used by employees who don't wish to actively manage their accounts and keep up with what is going on in the markets.
Target date investors contribute to only one fund for their entire careers. They invest in the fund named for the year closest to their expected retirement date. The average target date fund expense ratio in 2015 was 53 basis points, or .53%. The target date funds your plan uses should have expense ratios that are close to that average to be considered cost-efficient.
Why is cost so important in a target date series? The highest-rated target series also tend to be the lowest cost. They achieve a lower average cost by including index investments within their underlying investments.
3. Availability of investment advice
Nearly all large 401(k) plans offer an investment advice option. Many investment advice options are free and are algorithm based.
Better 401(k) plans offer more than one option. For some options, like Financial Engines, employees may pay a fee to obtain a more personalized level of advice.
4. Feedback on how you are doing
On each of a plan participant’s quarterly statements, they should have information enabling them to gauge whether they’re on track to accumulate a balance large enough to fund the retirement they desire.
This information could appear as an expected replacement ratio (for example, they are on track to replace 80% of their earnings) or it could be displayed as some sort of retirement readiness measure (they are in the red zone and not contributing enough).
5. Retirement calculators and projection tools
Planning is an important part of achieving. Your recordkeeper's website, the same site they log into to view your account balance, should offer a robust selection of planning tools.
From retirement calculators to basic projection tools, a client should be able to determine an expected 401(k) balance and what contribution rate is necessary to achieve it. They should also be able to add in a projected Social Security income stream and annuitize other balances (personal, spousal, other 401(k) plans) to derive a projected monthly retirement income estimate.
Investors who achieve their retirement savings goals effectively use these types of planning tools.
6. All employees understand the plan
The best 401(k) plans are well understood by employees. These plans tend to have straight-forward plan designs and a management team that can explain the plan easily.
For example, while visiting one of my clients, I heard employees say in an employee education session, "Look, you need to be in the 401(k) plan and you need to contribute at least 8% to receive the maximum company match. It's that simple."
If an employee doesn’t understand his or her 401(k) plan, there's a good chance they won't get the most out of it.
7. Senior management talks about the plan
All of the best plans, without exception, receive significant support from the company's leadership team. Company executives not only talk about the plan at official corporate gatherings, they feature it as a recruiting and retention tool in their everyday conversations.
How would you rate your 401(k) plan on these factors?