10 Ways Your 401(k) Can Fail You

BOSTON (TheStreet) -- A quick way for any website or publication to grab eyeballs is to either predict the demise of 401(k) plans or lament their shortcomings.

The doom and gloom isn't entirely unwarranted. Intended as an alternative to traditional pensions, 401(k)s have offered both success and failure to investors. Some of those failings are self-inflicted by investors -- not saving enough, taking loans and hardship withdrawals. The more than $1 trillion lost to the market collapse of 2007-08, however, was an unavoidable disaster, especially for those nearing retirement.

We took a look at some of the ways 401(k)s, by design -- though not necessarily intent -- can fail you:

1. Fees

A quality retirement plan doesn't come cheap. There are administration, compliance, recordkeeping and other costs to pay for -- not to mention the fees all those mutual funds entail.

In some cases, you may get what you pay for. A top-performing, actively managed fund may be worth every extra basis point. The problem is that the average 401(k) participant has no point of reference for these extra costs. To make a comparison, someone who knows nothing about automobiles might never know $15 is far too much to pay for a spark plug.

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Throughout the year, new federal regulations will provide participants with detailed information on what these fees are and what they are used for, but it will take time for many to grasp which fees are reasonable. Many, unfortunately, may not even try to evaluate these added costs, just as they have never dug into their Form 5500 in the past.

That's a shame, because your savings can take a severe hit. An employee with 35 years until retirement and a 401(k) account balance of $25,000 is offered by the Department of Labor as an example. If returns on investments average 7% and fees and expenses reduce average returns by 0.5%, the account balance will grow to $227,000 at retirement, even with no further contributions. If fees and expenses are 1.5%, the balance will grow to only $163,000, a 28% drop.

2. Limited offerings

In years past, "the more the merrier" was the approach taken to investment options in a 401(k) plan. It wouldn't be uncommon to have 30 to 40 funds to choose from.

Today, "less is more" is the strategy, with a smaller, less confusing array of investment options to choose from and target date funds intended as a no-fuss way to get started.

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The problem is that your workplace plan may not keep pace as you get more financially savvy. Major asset classes may be represented, and you likely have small-cap, large-cap, stable value and money market funds to choose from. But if your strategy calls for midcap equities, TIPS, commodities, emerging markets or REITs, you may find the rather generic menu options unsatisfactory.

3. Poor communication

Back in the dire days of the Great Recession, many couldn't bear seeing their retirement savings plummet. They just stopped opening their statements.

That ostrich-worthy strategy can be disastrous; you can't fix a problem -- or change course -- when you don't even know how bad things are and why.

Which raises a potential problem you may not even be aware of. Do you get your quarterly statements in a timely fashion? Are they issued reliably and arrive like clockwork when you expect them?

Today's volatile markets mean that decisions often need to be made quickly (although certainly not by headline-chasing, we hope). It's crucial for you to keep constant tabs on your 401(k)'s performance and how its investments fare. You also need to make sure your employer is transmitting retirement contributions accurately and in a timely fashion.

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The erratic delivery of your 401(k) statements, even if the data are available online, may be a red flag.

4. Reliance on employers

Even the most savvy self-starters can need to rely on their employer for financial needs that go beyond a paycheck.

A study released in March by MetLife MET found that nearly half (49%) of surveyed employees said that because of the economy they are counting on employers' benefits programs to help with their financial protection needs.

The survey also found that only 39% of employees feel "very confident" in their ability to make the right financial decisions; 72% wanted financial education programs made available in the workplace. Meanwhile, 91% of employers said they "feel strongly" that benefit programs can be used to retain employees; 86% said they "greatly increase" employee productivity.

A solid 401(k) offering would certainly seem a win-win for all involved. Nevertheless, your retirement security is still -- for better or worse -- in the hands of your employer. That 401(k) match you get can come or go with the company's bottom line. Other employees push company stock as part of their "match," something that -- loyalty aside -- isn't always a smart, compatible investment. Unscrupulous managers could even take kickbacks in exchange for pushing fee-heavy offerings or take loans against the plan.

5. Bad management

Is your 401(k) being properly managed? Even the best plan can fall victim to oversights and mistakes with the potential to erode your savings.

The IRS keeps tabs on common mistakes made by benefit providers. Among the problems: not updating plan documents; failing to operate in compliance with plan documents; not following procedures for deferrals and allocations; inconsistencies with contribution matches; depositing elective deferrals in a timely fashion; and making sure loans and hardship distributions were handled properly.

6. Complacency

Your 401(k) can make it feel a bit like a savings account. Don't treat it that way, however. It may be designed to "set it and forget it," but don't be lulled.

No matter how much control you exert, many day-to-day, quarter-to-quarter decisions will be out of your hands. The importance of having competent people working behind the scenes on your behalf has already been stressed. But even if you are happy with returns and service, make sure to always keep tabs and follow where your money goes.

Don't be afraid to seek out professional help as you evaluate your plan and ensure that investment decisions are wise, in tune with your objectives and fall within your risk tolerance.

7. Manager instability

Not only do you want to make sure your investments are in competent hands; you want to be looking for stability.

Form 5500, the government-mandated annual report required of employee benefit plans, can help you keep tabs on when key people leave or, even worse, are fired (see line items in Section 25). Similarly, you should keep up to date on the management of the funds you invest in.

Change is inevitable, but instability could be bad news for your returns.

8. Government needs

The tax-deferred status of 401(k) plans is an inherent strength that, in theory, allows you to save more and give less away to the government down the road.

The problem, like any other tax strategy, is that the government can change the rules. Among the ideas floated to reduce government tax expenditures are capping pretax contributions and chipping away at retirement savings deductions.

9. Limited death benefits

The sad reality is that all your careful saving and investing won't eliminate the possibility you pass away before collecting on it. Unfortunately, 401(k)s are't the greatest vehicle for passing along those savings.

You can, of course, set a beneficiary -- your husband or wife, for example -- and even establish a backup plan in the form of contingent beneficiaries.

Unfortunately, unlike IRAs, there is no built-in "stretch" option that allows heirs to take only a required minimum distribution (based on their IRS life expectancy tables) and let the balance grow tax-deferred.

New laws, as well as plan policies, have sought to give your extended family some of the same advantages as a spouse. You still will want to make sure, however, a plan is in place to make sure your heirs don't see your decades of savings evaporate through federal, state and estate taxes.

10. Rollover needs

A sad fact of modern life is that people seldom stay with one employer for their entire career. That also means no single 401(k) plan, tied as they are to your workplace, will stick with you for life.

The temptation, for many -- upon quitting, being laid off or fired -- is to just cash out and suffer penalties and taxes for some quick money. Others will procrastinate and leave behind an orphaned plan that lacks fresh contributions and needed oversight.

The best strategy is to roll over that new account into one of the many flavors of IRAs or a new employer-sponsored account. Before taking any step, make sure your rollover plan is ready to roll (some employers may be slow to release funds) and investigate restrictions and fees you may face with your new strategy.


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