A 401(k) plan is broken when the fund expenses overwhelm the tax benefit of participation. Employer sponsored 401(k) and similar tax-deferred savings plans encourage employees to save for retirement by deferring income taxes on their contributions. However, a recent study suggests that about 1 in 7 plans provide investment options that are so expensive that young workers would be better off not participating. They would be better off paying taxes and investing after-tax in low-cost index funds.
While that’s a very important point — fees do potentially eat up a huge swath of the returns that participants may otherwise have gotten — it’s important to also note that the analysis doesn’t always apply, even with high-fee plans.
First off, a big part of the underperformance reported in the study Rick cites is losses due to poor selection of funds, not the high fees alone. That part, at least, may be mitigated by consulting with a professional who can help steer clients into the better funds available (even if “better” only means “less bad” or simply “more appropriate”).
But secondly, and very importantly, the study assumes that the investor is going to stay with that employer — and that poor plan — for a long time. In reality, people change jobs on average in the US every 4 years. *Four* years. That means that, on average, every four years the employee would have the opportunity to roll over that balance into an IRA and select the best possible funds at the lowest possible cost.
And even in the case of employees not leaving their jobs every four years, plans change and often do get better. Awareness of these kinds of issues and letting other employees and management know are all great first steps towards improving this situation.
And lastly, one needs to be aware that returns are not the only consideration. If the only alternatives are taxable accounts, then there may still be a value to putting money into the 401k even with lower expected returns: For example: the money is better protected in the case of lawsuits; and the money is generally off the table when it comes time to apply for college financial aid.
So the short story is that, still, even with those exceptions (1 in 7), most folks should probably still be maxing out their opportunities to save money via employer-based 401(k) plans.
And don’t let the scare stories about poor plans scare you. Most of the plans, for most of the largest employers, are quite good, some of them absolutely excellent. In fact, while many financial advisors have a strong incentive to have their clients roll over former employer 401(k) plans into IRAs (that they manage), we regularly advise clients to leave money where it is with former employers when those former employer plans are great. Or, similarly, if their new employer’s plan is great, it may make a lot of sense to roll a former employer plan into a new employer’s plan rather than roll it to an IRA. That’s how great many of them are.
The bottom line is that you can’t really generalize. Every individual, every plan, and every situation is unique. And if you’re not sure how good your plan is, you may be very well served by consulting with a professional. The money saved is going to be your own.