5 Ways to Maximize Your Rigged 401(k) Plan

You may have to make do with a less than ideal 401(k).

white egg with 401k written on...
ShutterstockYour plan's fund families will offer financial advice, but that advice is full of conflicts.
By Daniel Solin

Unfortunately, the primary purpose of your 401(k) plan seems to be to enrich just about everyone but you.

For starters, most 401(k) plans are bundled and lumped together with administrative fees and expenses charged by the funds in the plan.

The 401(k) vendor (mutual fund firms, brokerage houses or insurance companies) controls the investment options available in the plan. In most plans, actively managed funds (where the fund manager attempts to beat a designated benchmark) dominate the available options. Because these funds charge significantly higher management fees (called "expense ratios") than lower-cost index funds, the expected returns of active funds are lower than comparable index funds.

Mutual fund companies often pay a kickback (euphemistically called "revenue sharing") to be included as an investment option. Most index funds, exchange-traded funds and passively managed funds don't pay revenue sharing, so including them would require the company to kick in some cash to cover the overhead. That is unlikely to occur.

The primary beneficiaries of this cozy system are the mutual fund companies charging high fees for their actively managed funds. Participants are often confronted with a dizzying array of actively managed mutual funds, with few or no index fund options.

It would be fairly easy to fix this flawed system. In fact, the federal government has already shown us the way. The Thrift Savings Plan is a defined contribution plan administered by the Federal Retirement Thrift Investment Board, an independent government agency. The board is required to manage the plan "prudently and solely in the interest of the participants and their beneficiaries."

What's so great about this plan? All of the investment options in the plan are extremely low-cost index funds. The plan has no actively managed funds and uses the leverage of its huge size to negotiate extremely low fees. Net administrative expenses in 2013 for five out of six Thrift Savings Plan funds were less than 0.03 percent.

Your 401(k) plan should emulate the features of the Thrift Savings Plan. It should offer portfolios of index funds, ETFs or passively managed funds at various risk levels. It shouldn't have any actively managed funds as investment options. It should negotiate the lowest fees it can, based upon the size of the plan.

Unfortunately, this is not going to happen. You are likely going to be left with trying to make the best of a bad 401(k). Here are some suggestions to do so:

1. Look for index funds. Although most plans are dominated by poor investment choices, many of them will toss in a few index funds for optics. If you can find a domestic stock index fund, an international stock index fund and a bond market index fund, you will be able to put together a portfolio with a suitable asset allocation (the division of your funds between stocks and bonds).

2. Focus on fees. If you are stuck with choosing from investment options consisting only of actively managed funds, pick the ones in each asset class with the lowest expense ratio. Avoid all funds that hit you with a sales charge.

3. Avoid company stock. Some companies encourage the purchase of company stock in 401(k) plans. They may even make matching contributions in company stock. You should avoid purchasing company stock in your 401(k) plan. You are already "invested" because you depend on your company for your paycheck. It would be a devastating blow if your company went out of business and you lost your job. Don't compound that risk by adding company stock to your 401(k) plan.

4. Be wary of financial advice. The same fund families that manage high-expense-ratio, actively managed funds in your plan often offer "financial advice" to plan participants. You should be wary of this advice. It is rife with conflicts. The fund family increases profits by steering you into its more expensive funds (including its proprietary funds) and away from low-cost index funds. It is in your best interest to focus on fees and select low-cost index funds if they are available.

Relying on sound financial advice from those people who populate your plan with poor choices is akin to hiring the fox to guard the hen house.

5. Minimize your reliance on your 401(k) plan. If you have a bad plan and your employer does not make any matching contribution, consider not participating. If your employer does offer a match, consider contributing the minimum amount necessary to obtain the maximum employer contribution.

Supplement your retirement savings by opening an individual retirement account (either a traditional IRA or a Roth IRA, if you qualify) and invest some of the money that you normally would have tucked away inside your 401(k). With your own IRA, you control your investment choices.

The securities lobby has successfully opposed meaningful reform of the 401(k) system. There is little incentive for Congress to act in your best interest. After all, its members are beneficiaries of a superbly run 401(k) plan, and they apparently don't believe your plan should replicate theirs.

You are basically on your own to navigate around a system that many believe is a national disgrace.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book, "The Smartest Sales Book You'll Ever Read," has just been published.

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Yup James

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June 20 2014 at 1:48 AM Report abuse rate up rate down Reply

Hi Dan:

I think the 5 things to do are the right things, but there is a huge mis-characterization in this article. The Plan Sponsor (employer) is ultimately the only one responsible for the funds in the plan and who is allowed to provide financial advice. If they choose a bundled provider with *free* services then the responsibility is on them.

June 18 2014 at 6:18 PM Report abuse -1 rate up rate down Reply

Greed. Our Republican greed experts never pass up a chance to squeeze a few last drops of blood out of the body before kicking it to the curb. The problem is that soon they will have killed off their cash cow and wonder what happened. A greedy but smart Republican knows it is wise to keep the slave in good health so they will be able to crank out more cash. I am a liberal that believes the radical greedy ones need to be kicked out of the Republican club. Keep the general population at a level of wealth that supports the immoral Republican base and their lust for power and money.

June 18 2014 at 4:18 PM Report abuse rate up rate down Reply

The Republicans have been destroying the middle class for generations. Union busting and outsourcing their jobs.

June 18 2014 at 1:03 PM Report abuse +1 rate up rate down Reply

Democrats, screwing the country for generations.

June 18 2014 at 12:19 PM Report abuse rate up rate down Reply

There was little incentive to overhaul the healthcare system thanks to lobbyists and their Republican aliies! Yet they've done it. Why can't they follow suit with retirement plans and while they are at it reduce the heavy taxes imposed on them when withdrawals are made based on your income and means. It's hard enough saving at all without the IRS taking a significant portion of it making us more financially strapped! People with retirement incomes under $100K should be heavily taxed! Some people only have social security and some savings. Too much of it has to go to taxes!

June 18 2014 at 12:12 PM Report abuse -1 rate up rate down Reply
1 reply to boston1936's comment

I meant to say people with incomes under $100K SHOULD NOT BE heavily taxed! Why can't the first $25K income be tax exempt, with 10% on the next $25K up to $100K for example? Help people instead of making them poor in retirement. And Republicans still try to rip us off of the social security and medicare benefits we have now. It wasn't enough to destroy pensions make passing legislation that made it easier for companies to dump them!

June 18 2014 at 12:15 PM Report abuse -2 rate up rate down Reply

On social security and medicare or soon to be, thank a democrat. If you want to end these two fine programs vote republican.

June 18 2014 at 9:38 AM Report abuse -2 rate up rate down Reply
2 replies to toosmart4u's comment

Agreed. But the Dems could at least propose legislation to overhaul our lousy retirement plan system like they did healthcare. Making the effort and publicizing it at least brings it into the national debate even though the special interest lobbies will try to derail it!

June 18 2014 at 12:08 PM Report abuse -2 rate up rate down Reply

Blah, Blah, Blah. The same old crap from you, ya dolt.

June 18 2014 at 12:18 PM Report abuse +1 rate up rate down Reply