What Your 401(k) Isn’t Telling You

Carla Fried



In the past few years there have been some smart innovations in how 401(k) plans are run. But while the changes are for the benefit of participants-that’s us-there are some hidden consequences that can impede your ability to build a secure retirement:


Here’s what your 401(k) might not be telling you:

• Don’t Settle for the Default Contribution Rate. One of the best innovations in 401(k)s over the past few years is to automatically enroll new employees in a company’s plan rather than wait for the employee to sign on. (You can always opt-out of any plan you are enrolled in.) But when most plans automatically enroll workers they also typically set the employee’s contribution rate at 3 percent of salary.

Here’s what your 401(k) isn’t telling you: You will never reach your retirement goals if you save just 3 percent of your salary. Even if your employer kicks in a matching contribution, that’s not going to cut it. For anyone in their 20s, financial advisors typically recommend setting aside at least 10 percent (combined employer and employee contributions.) If you’re just getting started in your 30s and 40s, the advice is to aim to save 15 percent of your salary.

Now some 401(k) plans have also added an “auto-escalation” feature that periodically—once a year, or when you receive a raise-increases your 401(k) contribution rate. But they are the exception, not the norm. So it’s up to you to contact HR or your 401(k) plan and ask for your contribution rate to be increased. Aim for at least a 1 percent increase each year until you reach your 10 percent-15 percent target. And hey, this year push for a 2 percent increase. You won’t even see or feel the difference. As part of the recent tax bill that passed Congress, employee contributions into the Social Security system—that’s the FICA line item on your paycheck-have been reduced by 2 percentage points in 2011. Why not earmark that 2 percent “payroll tax break” for your 401(k) this year?


• Your Retirement Date is not the Same as the Target Date on Your Retirement Fund. Target-date retirement funds have become a popular option the past few years, and that’s a good development. Being able to have insta-diversification across an age-appropriate mix of stocks/bonds/cash in one fund is a heck of a lot easier than trying to make sense of choosing among a dozen or more individual funds offered in your plan.


But just make sure you understand how the fund company views your “target” retirement date. In the wake of the 2008 market crash, some 50-something employees invested in target date retirement funds with a 2010 or 2015 end date and were unpleasantly surprised to find out their funds had suffered big losses due to a big slug of stocks. That’s because most target-date funds are not focused on the date you are retiring-say age 62 or so-but instead are allocating the money on the assumption you will live well into your 80s or beyond. So while you may be focused on retiring in five years, the fund is focused on the need for your savings to continue to grow and support you for 20 or 30 more years. In the techno-speak of the 401(k) world this is known as the “To or Through” debate: does your target retirement fund allocate the assets to get you To retirement, or Through retirement? I am a big believer that you want to be investing Through retirement. But the takeaway here is to not assume anything, and understand exactly how your target fund operates and make sure you are comfortable with its assumptions, or that its allocations dovetail with your overall retirement savings strategy including your IRAs and other savings accounts.

• You’d be Better Off Not Investing in Our Company Stock. Or at least, not loading up on too much company stock. This has nothing to do with corporate loyalty, or the fact that you think your company is all-that. This is about sound portfolio management. And the sacrosanct rule here is to limit your investment in any individual issue to no more than 10 percent of your assets. Invest more than 10 percent in any single stock and you are taking too much risk, plain and simple. Yet a recent survey of 401(k) plan participants by Financial Engines reported that 23 percent of participants with access to company stock inside their 401(k) had more than 10 percent riding on their employer’s stock. Even if your firm makes its matching contribution into your account in company stock, most plans also give you the option of moving out of the company stock and into the other diversified funds offered in the plan. That’s a smart move to make today to ensure a more secure retirement.