With many people worried about Social Security, and more employers doing away with traditional pension plans, the 401(k) is taking on a greater significance for those planning for retirement. But how do you know if the 401(k) plan offered by your employers is a good one -- or a poorly run one?
Experts say there are definite warning signs you should be aware of. Here are four ways to spot when your 401(k) is being mismanaged:1. The Plan Charges High Annual Fees
"If a plan has abnormally-high fees, it's probably a sign that the company is not taking its fiduciary responsibility seriously," says Mike Alfred, co-founder and CEO of BrightScope, a free service that tracks and compares more than 55,000 401(k) plans.
How high is too high when it comes to fees? Alfred likes to see fees of about 1%. "Certainly, there are not a lot of services offered by 401(k) plans that are worth 2% a year. Nevertheless, such fees get charged all the time," he notes.
The issue of high fees is most prevalent among smaller business, where some 401(k) plans may impose yearly fees ranging from 3% to 5% of assets.
"But even for small companies, with only a dozen or so employees, there's really no good excuse to justify those kind of fees."
2. The Plan Has Major Gaps in Investment Options
The best 401(k) plans offer ample opportunities to invest in every asset class, including stocks, bonds, commodities, real estate, and so on. But some company plans are missing entire asset classes.
"If a 401(k) plan is missing key asset classes, it's a sign of mismanagement that almost rivals high fees," says Alfred. The problem with a plan that fails to provide, for example, a real estate fund or an international fund, is that you're missing out on significant investment opportunities and hurting your chances to diversify your portfolio.
3. The Plan Features Only One Family of Funds
Take a look at the investment choices in your 401(k). Are all the options from just one mutual fund company? That's a bad sign, according to Richard Coppa, a Certified Financial Planner and managing director of Wealth Health LLC.
"I always cringe at that," Coppa says. The issue with this is that you may suffer from what I call, "no manager selection," and what Coppa calls "no intellectual diversification."
A related issue is having just one fund from a company in a specific asset class: like small cap stocks. If your 401(k) plan only offers a single small cap fund, it may be underperforming its peers or the broader market.
4. The Plan is An Insurance-Based Plan
Most investments in 401(k) plans are in mutual funds of one kind or another. But Coppa notes that among plans that are insurance-backed plans, "they typically have a lot of extra fees embedded in them."
That's because these offerings don't offer direct investments in mutual funds. Instead, your money is invested in separate accounts that are "wrapped in an insurance-based product."
Why do employers saddle employees with these more costly, insurance-based 401(k) plans? Coppa says it's sometimes cheaper for the company, and that businesses can get a "turnkey" solution from a financial institution, too. "For instance, John Hancock may be providing the company's life insurance or other insurance benefits, and then they say 'We can serve as your 401(k) plan administrator, too.'"
Ultimately, it's up to you to do your homework, and get as much information on your 401(k) plan.
BrightScope's service can help. Right now, it's the only free tool of its kind that's available to the public. Most importantly, BrightScope's evaluation looks at only those fees you pay -- not the administrative costs that may be borne by your employer. It's the fees paid by 401(k) participants that can eat away at your returns, especially over long periods of time.
Indeed, a 2009 report from the Government Accountability Office found that many individuals participating in 401(k) plans are completely unaware of the impact that investment fees and other "hidden" charges may be having on their nest eggs.
When investors are made aware of those fees, they are often shocked -- and angry. In recent years, a number of well-known companies -- ranging from Lockheed Martin to Walmart -- have been slapped with class action lawsuits by employees who were dissatisfied with their 401(k) plans and fees.
In years when the stock market is waning, companies are more at risk of such suits. After all, most people won't fuss about their 401(k) plan if it's posting double-digit returns. When that same plan suffers a 10% to 20% drop -- or even greater -- it's almost certain to be subjected to greater scrutiny.
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