Is It Worth Contributing to a Bad Employer 401(k) Plan? Here's What to Do!

In this video, we'll talk about how to decide whether contributing to a bad 401(k) plan is worth it. You’ll learn the key factors to consider, including which investment options you should look at. We'll also talk about strategies for minimizing the downsides of a bad 401(k) plan while still preparing for retirement.

How we invest our 401(k) video: https://www.youtube.com/watch?v=v9g_uOw8sbU

Resources:

- Alliance of Comprehensive Planners: https://www.acplanners.org

- John's firm website: https://www.trinfin.com

- Find us on Facebook: https://www.facebook.com/friendstalkfinancialplanning

TRANSCRIPT:

Bridget: Now most HR people are not 401(k) experts and they're usually the person contracting this, so if you can tell them, “Hey, I would really like it if we had a better 401(k). And these are the things that I would like—some index funds, some lower fees.”

John: Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. Before we talk about bad 401(k)s, why don't we remind you to like and subscribe to our videos. That helps other people find us. Okay, John, what are your ideas? Bad 401(k)s. What's the first thing you think?

John: Bad 401(k)s sounds like a terrible name for a rock band or something like that. But I mean the question comes up, sometimes it's with a friend, sometimes it’s with a client. And you go “Geez, my 401(k) at work really stinks in some fashion. Should I contribute to it?” So that's sort of the core question: should you contribute to a 401(k) when it's not very good? And I thought maybe we'd start just by talking about what does that mean if there's a bad 401(k)?

I've got a couple of examples of things that I've seen over the years, and I'd be interested to hear if you've got anything different on that, Bridget. And one thing is investment fees. And investment fees are getting better these days, but it's still not completely uncommon to see high fees. It used to be really common. We see especially with smaller retirement plans, smaller businesses that the investment options inside of those plans can be really expensive. Now what do I mean by that?

Inside mutual funds are typically what we see in retirement plans, sometimes exchange traded funds, so where there's an expense charge that we pay a manager for to do the actual investing for us inside. And these days we'll see expense ratios at like 0.1% or 0.2% or 0.3%. And those have been around for a long time. Now we're seeing more and more investments like that. But I just looked at a plan not long ago and the average fee inside that at the investment plan was over 1%. It was 1.05% or something like that. Why is that significant?

You're paying literally 10 times as much, maybe 20 times as much for the fund management. And as your money starts to grow, if you got a million dollars in your account and you're paying an extra 1%, that means you're paying $10,000 a year for investment expenses that you probably don't need. So some of these plans have some really unattractive pricing and you got to kind of look underneath the hood and see what the costs are. But that's one example of things we still see: the investments are really expensive.

And there are two other places. One other place we have a plan with a bigger company around, and their expenses are really good in their plan, but they've got basically three funds. They've got a stable value, cash-like fund. They've got a US stock S&P 500 index fund, and they've got an international index fund. Not wrong. You can build a decent portfolio, but there're no small company stocks, which we like to have small company stocks. There’re no emerging market stocks. There're no bond funds. Again, is that necessarily wrong? No, it's better than having a super expensive account. But geez, you can't fully diversify the way that I like to do it anyway.

And you go, “Okay, that's not how I would put it together. Do I still want to use that fund or that 401(k)?” And then the other thing I'll throw out there, and I want to get your feedback, Bridget, is there's a lot of places yet that having a match inside your 401(k) is pretty common. But there’s still a lot of places where there is no match; I put money in, and I don't get a company match. If you do get a company match, it's like free money. That's an absolute no brainer. If I don't get a match, is that still the best place to put my money? I don't know if you see anything other than those as far as bad 401(k) plans.

Bridget: Yeah. The thing that I would mention is that sometimes you see actual fees coming out of the account, so that would be one thing to look at. And then like you said, when I'm trying to pick what to invest in in a 401(k), my main criteria is what are the expenses in that fund? So if I see something over 1%, and if everything in that 401(k) is over 1%, those are all my options, I would classify that as a bad 401(k). And usually what I look for with my eagle eye is index funds and see what the index funds are.

I’ve seen index funds over 1%. If it's a small 401(k), sometimes it’s the way that it's structured to pay for this 401(k). If the company doesn't want to pay upfront for it, they have the expenses of the 401(k) kind of passed off to these funds. And so that makes the expense funds high, or maybe sometimes these places are making a ton of money. I don't know. That's why the expenses tend to be high. So that's kind of my guideline for what's way too high, what’s high, and how to try to just look at that expense ratio. And then what you're mentioning is, what type of asset is that? Large cap, small cap, international, and you kind of want a mix of that stuff.

John: Yep.

Bridget: So those are my thoughts on it. And then the ones that have barely any funds are preferable to the ones that are expensive. But the other thing is that most of the time, until you're close to retirement, you don't have tons of money in these things, and a lot of people job hop, so then you could not move your money to the bad fund. That's one of the things that we've done with clients. If we see bad 401(k)s, we just say, “All right, why don't you just keep the good ones? And if your current company has bad ones, then when you leave the company, I'll put it into an old, better one.” That's okay. It's okay to have multiple 401(k)s, if one happens to be bad.

John: All right, so here’s an example. I've got a 401(k) plan. It's pretty expensive and there's no company match. Should I still put money into?

Bridget: It depends on your tax bracket. That's what I would say. If you're in low tax brackets, I would say, don't bother. Just put money into a Roth 401(k), especially when you're young. If you're older and your tax bracket's 22%, 24%, then I would say usually that tax deduction is good enough so that it's probably worth it. I would also say if you're getting a match, you should contribute up to the match. That's going to be worth it.

John: Yeah.

Bridget: But with no match, I would say it makes it easier to save. So you have to know yourself and say, “Am I going to save money? Can I make this automatic some other way? Or am I deluding myself that I'm not going to contribute to this bad 401(k)s and then just not save anything and just spend?”

John: Right.

Bridget: You have to be able to have some self-reflection there if you're not going to save 10% just in your 401(k), which just makes it easy to save 10% of your income.

John: Right. It's like paying off a mortgage. I'm not a big believer in paying off a mortgage early and I know that you're not necessarily either. But listen, if your alternative is you're going to save that money, awesome. If you're going to spend that money, well, shoot, paying off your mortgage is probably a better deal than buying and then wasting it on whatever stuff you buy on Amazon or whatever it is. These questions come up, and I kind of know how to answer them instinctively.

And it's interesting to hear you say the same thing. For me, if you're getting a company match that is literally free money. A typical match would be dollar for dollar on the first 3% or something similar. I mean that's 100% return. I don't care what the expenses are, you can't beat 100% return. If you're not getting the match, it becomes a little bit more nuanced on things. One thing that I would take a look at is depending on the circumstances, you can always put money into an IRA, even if you've got a company plan through work, but it's not always deductible.

So I might look at it and go, hey, depending on how much money I'm making and where I'm putting the money, if I've got a relative, who's just starting off in his career making $50,000 or $60,000, for him to save 10% into his IRA, he can do that and fit within the limits and not necessarily participate or have to take the tax deduction for it. So that's an option for things. You can go where you've got an option to make that. I see a face like you don't like the IRA.

Bridget: Yeah, those are what's called non-deductible IRAs. Ultimately what you're supposed to do then is keep track for however many years you’re going to have this thing, like 30, 40 years. Keep track of this paperwork for 40 years, maybe longer than you even been alive, so that you know how much you put in and how much it's earned. And then you only have to pay tax on how much it's earned. Oh, wait, but if you don't do your own taxes, you have to communicate this with your tax advisor. This is beyond people’s ability to keep track of things. And so, I'm not a huge fan of non-deductible IRAs, although I know we do have one viewer who would probably disagree. But my alternative in that situation is just Roth.

John: I was going to say, if you're at that income level, that's probably a better place.

Bridget: Yeah, but it depends on your income level. Wait, here's another thing. You have some influence. For example, you look at your 401(k) account. It's terrible. Now, most HR people are not 401(k) experts. And they're usually the person contracting this. So if you can tell them, “Hey, I would really like it if we had a better 401(k). And these are the things that I would like—some index funds, some lower fees.” Easy.

John: Yeah.

Bridget: You can actually have more influence than you would think. Giving some feedback about your 401(k) can motivate them because they review this every so often. Believe it or not, you can go bug somebody and they can get a better 401(k). If nobody's thinking about it or nobody's giving them any feedback, it's probably going to stay the same.

John: Yeah, that's a great point, especially in a smaller company when your voice is perhaps louder relative to the masses in a bigger company.

Bridget: Yeah, well, I would say that I find that the places with worse 401(k)s tend to be places like social service, the place where people are focused on helping people and not on finances. So again, the person to recruit might be the person that keeps track of the finances there and say, “Hey, have you looked at our 401(k)? What do you think of it? Okay, why don't we go to HR?”

John: Yeah.

Bridget: And just mention that these are the things to look at. It could be better.

John: I just wanted to bring back one other thing that you had said earlier. Again, if you are more advanced in your career, the tax advantages of a 401(k) in my experience often outweigh what might be higher expenses depending on the circumstantial, such as no matching. And it can be deductions as you indicated. And we've got circumstances where using a Roth 401(k) can be an advantage. If you're over 50, you can put $30,000 or $41,000, something like that, into a plan and have that Roth advantage. Just having the tax location and having the ability to do that is not a reason you absolutely do it. But it's also something I think you really need to consider as you think about that.

Bridget: Yeah.

John: So, because there're some unique things that you won't have the opportunity to do once you’re retired. So consider that.

Bridget: I have not seen Roth 401(k)s in these bad 401(k)s. Because that's another kind of bell and whistle that they can sometimes have on 401(k)s, which is called the Roth 401(k). And those are usually more sophisticated plans, but if you had that, it’s a good thing to think about.

John: Hey, I think that's a great place to wrap things up here as we talk about bad 401(k)s. Again, I'm John Scherer, and I've got a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both members of the Alliance of Comprehensive Planners. We're taking clients, but if you're looking for an advisor in your area, you can check out acplanners.org. And before we leave, I want to mention there's another video that we did about how we invest our own 401(k)s and we'll put a link to that in the notes, so you can take a look at that next.

John: And please hit that subscribe button.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.