Analysis Paralysis in Your 401(k)

More choices equate to more confusion

Contributing to your employer's 401(k) plan is, by far, the biggest personal financial no-brainer. Where else can you get a guaranteed return of in excess of 100%? Yes, you read that right. When your employer matches your contribution, that means you doubled your investment. Actually, it gets better. In addition to the employer match, you save anywhere from 15 - 35 percent, depending on your tax bracket, by deferring the tax on that income. You might save an additional 6% if you live in a state with an income tax. Even if you choose to put that money in a money market fund, these gimme's make the 401(k) superior to just about any other option. Any financial planner worth his salt will tell you that maxing out your 401(k) contributions is the smartest thing you can do.

Now for the bad news. According to a 2004 study by the Human Resources firm Hewitt Associates, a large percentage of employees are failing to adequately manage their 401(k). Consider these awful statistics:

• Only 17 percent of participants made any transactions in their 401(k) beyond the automatic contribution.
• Only half of eligible workers in their 20s elect to participate.
• A significant percentage of participants direct their contribution to investment options such as money market funds, which are likely to deliver insufficient performance to meet retirement needs.
  
• When employees leave the company, half will elect to cash out their 401(k) rather than rolling it into an IRA, or another qualified plan. The penalties, which include a 10% IRS penalty, full taxation on the distribution which can max out at 35 percent, and the lost tax deferral on the entire distribution, can devastate a retirement plan.

A conclusion of this study was that workers are overwhelmed with the number of investment choices, even though they asked for them and got them. In the words of one University of Pennsylvania researcher, "most 401(k) participants are characterized by profound inertia." The consequences of this state of affairs will be dire, especially for the under 40 set, whose chances of receiving the level of benefits from Social Security diminish every year.

I have a solution to this mess, and yes, it includes a shameless plug. Employers should hire local advisers for their funds, so that in addition to a 401(k), comprehensive financial planning can be offered to each employee. Doing so increases the employee's participation rate, and improves the choices that the participants make.

This solution does not necessarily create more cost for the employer. The average expense ratio in a 401(k) is 1.57 percent, which is exceedingly expensive when you consider that the average mutual fund underperforms the market by a comparable sum. At First Sustainable, we can chop that figure in half, after adding in advisory fees. What's more, the employer can elect to have most of that figure paid by employees.

The benefits to this style are enormous. We offer free consultations to every employee, taking into account all aspects of the financial condition, including that of children and significant others. The large 401(k) providers have a 5 step questionnaire which is nothing more than an attempt to sell the most expensive funds.

If you have 3 employees or more, you should give us a call and let us show you how easy and inexpensive this can be. For employers, offering a 401(k) is the best employee recruitment and retention tool. For employees, as I said at the top, is the biggest no-brainer.