Whodunit? Solving the Mystery of Your Company 401(k)

When your company holds the bulk of your retirement savings, an uneasy relationship can keep you up at night like a creaking stair. What are some of the common worries employees share with regard to their 401(k)s? How can you feel more confident that your money is safe and you are not being done wrong? Let’s unravel the mystery together.

The Usual Suspects – What Funds to Choose

401(k)s must offer three or more substantially different fund choices. The trend of late is for plans to have a dizzying number of fund choices that can make it hard to know what to choose. When you decide which funds are best for you to invest in, you can feel pretty safe using the “target date funds” or index funds your company will probably offer. Those funds have some drawbacks but are considered to be good choices. You can also choose funds based on the rule of subtracting your age from a target age. For many years, conventional financial wisdom had us subtracting our age from 100 to get a target percent for stocks vs. bonds (if you're 30, you should keep 70% of your portfolio in stocks. If you're 70, you should keep 30% of your portfolio in stocks). Now financial professionals advise using anywhere from 110 to 125 as the top number, which means, if you use the top number, that at age 30 you’d keep 95 percent of your money in stocks and 55 percent in stocks if you are 70. The change has come about because people are living longer so they need the extra growth stocks can potentially provide to make their money last longer. Your plan will list all the funds you can choose from and describe their risk levels. Each plan will also have a very low to no-risk “stable” fund to choose for your non-stock holdings. You can make educated choices on how to invest your money based on this information.

The Hard-Boiled Private Detective – Should You Use a Financial Professional?

What if you are not comfortable making those investment decisions? Larger companies sometimes offer fee-based “professional advice” for 401(k) participants. They will manage your retirement portfolio for a percent fee of the balance you have. Let’s say that your company offers professional financial advice for a fee of 0.7% of your assets under management. That means that in addition to the fees that are charged in general for fund management, if you had a $150,000 balance, you would pay $1,050 that year for a professional to manage the investments in there. It may be worth it to you to pay for that service, but you needn’t feel that you must use it.

The Smoking Gun – Known and Hidden Fees

Management of 401(k)s isn’t free. According to the Department of Labor (DOL), 401(k) fees can sometimes be excessive and can reduce your returns over time. The DOL provides this example: assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

The Locked Room – How To Get Your Money Out

401(k)s have rules about when you can withdraw your money without penalty. If you need to borrow, withdraw, or take distribution of your money, you do so through the plan administrator. It may mean selling investments in mutual funds to do so, which could be at a loss to you. This Nerdwallet blog covers early withdrawal penalties. However, the money you contributed to your 401(k) is ALWAYS yours.

The Clean Getaway – When You Resign

When you leave your job for any reason, you have the right to move your contributed money out of your 401(k) or to leave the money there, continuing to be invested as you direct. If you want to move the money, it’s best to “roll over” your funds to your new company’s 401(k), to a self-directed IRA, or to an IRA managed by a financial advisor. You want to avoid taking a distribution or withdrawing your money if possible. When you withdraw 401(k) money it loses its protected status after 60 days of not being put into another qualified retirement plan. In the business of life, it’s possible that you might forget to set up a retirement account to receive that money and end up having to pay taxes and penalties.

The Body in the Library – If You Are Fired

In the event you are fired for cause (as opposed to being laid off because the company doesn’t have work for you), the money you contributed to your 401(k) is still yours. Your company may have also contributed to your account during the time you were employed. The plan will specify the rules for when the company-contributed money is yours – called “vesting” – and if you meet the time guidelines, you will also take with you the money that the company put in.

The Butler Did It – Company Bankruptcy

What if my company goes bankrupt or closes? 401(k) funds are separate from company accounts and are administered by an entity other than your company. However, if your company goes bankrupt without depositing their promised match to your account, you’d lose that money. You could also conceivably lose one paycheck’s worth of 401(k) contributions if the company didn’t deposit the money you’d allocated into the plan.

The Impregnable Safe – Is My Money Insured?

Is retirement money insured? First let’s distinguish between what your retirement money is held in – bank deposits (basically cash) or investments (mutual funds, stocks, ETFs, etc). If your retirement funds are in an individual bank account, they insured by the Federal Deposit Insurance Company (FDIC) up to $250,000. If you have bank deposits in a company 401(k), you get up to $100,000 of FDIC protection. If your retirement funds are invested in securities (which includes mutual funds), they are insured up to $500,000 against fraud or bankruptcy by the Securities Investors Protection Corporation (SIPC) if your brokerage firm is a member (which they probably are). If the entity that holds your money goes bankrupt (highly unlikely but not impossible), you would lose any funds over that $500,000 limit. Keep in mind that the SIPC does NOT protect you if your investments do poorly. If bad luck or poor decisions result in losses, your retirement nest egg is gone.

A Stab in the Dark – What Are the Risks?

Depending on the mutual funds you invest in with your 401(k), you will incur risk. Investments are risky! Keep this comparison in mind - If you leave $1,000 in a no-interest checking account, 30 years later you will have $1,000. However, if you leave $1,000 in a mutual fund for 30 years, you could have $100,000 or you could have $0. Mutual funds are based on the stock market, and you can lose money there just as easily as you can gain it. The rewards of investing are high, but so are the risks. It’s important to keep in mind the fact the risk means that someone may lose. If that someone is you and your money is gone, that abstract concept becomes very real and very painful. If you earn a great return and you double or triple your money, your risk-taking will prove to be the right decision.

Solving the Mystery

Company 401(k)s offer a great way to prepare for retirement. Be sure to put yours under the magnifying glass to make sure you identify as many clues as possible for a great retirement.