Your company 401K can be a great way for your employees to save for retirement, especially if you offer a match on employee contributions. Saving sooner rather than later will also mean retirement account balances are likely higher when employees reach retirement. But, as a business owner, are you really making the most of your company 401K? If you’re not following these 6 practices, then chances are you’re not.
6. Keep Fees Low
It can be difficult to control the costs of your investments. Many come with hidden fees—fees you may not even realize you’re paying since they never show up on your statements. One of the best things you can do to reduce costs is move the plan’s investment options away from high-fee, actively managed funds and use low-fee index funds instead. Research from The Vanguard Group and Morningstar has shown that doing so will leave more money in your employees’ pockets as they save for retirement. You should also know that, since more than 80% of actively managed funds don’t beat their benchmarks, using actively managed mutual funds in your 401K also means your employees are probably paying for underperformance.
5. Get Fiduciary Oversight by a Professional Advisor
Have you engaged a Financial Advisor to manage your 401K account? If you haven’t, then you should. Fiduciary oversight is an important aspect of keeping your plan on the up and up with recent legislation and regulation. When you’re shopping for an advisor, be sure to find out if your potential advisor is a broker or a fiduciary; the difference is crucial to the performance of your account. Fiduciary 401K advisors are held to higher standards than brokers, who are usually operating on what’s known as a “suitability” standard. Brokers may sell you any product so long as it’s deemed “suitable.” That means an unscrupulous broker might sell you a financial product that doesn’t make sense for your portfolio—because that product pays them a higher commission. A fiduciary advisor, on the other hand, must act in the client’s best interests, which guarantees better oversight of your investments. Recent DOL rule changes will require all advisors to be fiduciaries in the near future.
4. Use Index Funds
For people entering into retirement, having good market performance is a prime concern. After all, many will rely on those investments—including their 401K holdings—to finance their retirement. Actively managed funds are typically expensive, but they have another downfall: they rely on human beings to pick winning and losing assets. Index funds, on the other hand, are passively managed by computers to track an index such as the S&P 500. Index funds typically come with much lower fees than actively managed funds—and they’re more likely to give your portfolio better, more consistent performance. In fact, according to studies by Morningstar index funds successfully outperform actively managed mutual funds in almost every asset class.
3. Talk Tax
How you save in your 401K can have a big impact on your taxes in retirement. With a traditional 401K, employees contribute from pre-tax dollars, and they won’t pay tax until you withdraw the money in retirement. If you think you’ll end up in a lower tax bracket once you retire, then this makes sense. With a Roth 401K, on the other hand, employees contribute with after-tax dollars. When you withdraw the money in retirement, you don’t need to pay tax on the money paid into the plan (since it went in after-tax) or on any gains in the account. If you anticipate you’ll be in a higher tax bracket later on in life, this feature can save you money. Predicting where taxes will be in 10, 20, or 30 years is nearly impossible, so you might consider offering both a Traditional and ROTH 401K. Saving equal amounts in your traditional and Roth 401K can be a good hedge against higher or lower tax rates when you retire.
2. Don’t Encourage Borrowing from the 401K
A loan on a 401K can be tempting to almost any employees, especially if you have a big purchase or an unexpected bill crop up. The problem is that taking out that loan could mean hamstringing your 401k with low growth. Why? Your plan has an established interest rate on your loan. If it is 2%, for example, then you have taken the money out of the market for a low return and missed out on potential growth in your retirement account. As a general rule, don’t encourage employees to use the 401K as a home equity loan or the equivalent, and don’t allow the plan to permit employees to take out multiple loans; this will only drive employees into deeper debt. Loans should only be taken as a last resort. Your 401K needs to be invested in a diversified global portfolio over a long period of time to deliver the growth you can reasonably expect so that you can retire comfortably.
1. Make sure Employees Save more than the Default Savings Rate
Most employers with a 401K plan are now auto-enrolling employees, usually at a savings rate of around 3% or 4% of salary. While that’s certainly better than not saving at all, for most people, that won’t be nearly enough to sustain them in retirement. Most experts recommend a savings rate of between 10% and 15% of salary, depending on your age and the amount of savings you have outside of your 401K. So make sure your employees know that the default savings rate of 3% to 4% that your plan offers is only a starting point and that they need to increase the percentage significantly to save for a comfortable retirement.
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation. Thayer Partners LLC does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.