The 5 Myths About Your 401(k)

The 5 Myths About Your 401(k)

January 25, 2024

Check out my contribution to an article published in US News & World Report...

The 5 Myths About Your 401(k)
Think you know all about your retirement plan? Don't be too sure.
By Christine Giordano Contributor January 25, 2016

With their fees and percentages, funds and corporate matches, 401(k)s have been known to baffle and confuse even the smartest people in the office. In fact, even businesses offering the plans can be confused.

When asked, 83 percent of small business owners say they have questions about their company's 401(k) plans, and a third of them feel they need to hire a consultant to settle their confusion, according to a 2012 national survey of small business owners conducted by ShareBuilder 401k. Many are unprepared for questions from their employees, according to the survey.

As an employee, if your company is offering a 401(k) match, consider it free money, but there are some things you should definitely research. Your best plan of action should be to stay educated and learn as much as you can about your plan.

Here are some myths about 401(k) plans:

Myth: The amount you save under your corporate match program will be all you need to retire. Experts say you should put away more than your employer's match to protect yourself from rising costs of living, inflation and unexpected medical bills. You'll need to do a little extra math.

"While it's always good to put in at least as much as your employer matches, 99 percent of the time, you need to put in more," says Layton Cox, director of retirement plan consulting for Pathways Financial Partners in Tucson, Arizona.

If the cost of living increases by 3 percent each year, you'll need more money to be comfortable in the future. "If you are, say, 25 years from retirement, and want to have a lifestyle that requires you to spend $100,000 a year in today's dollars, you are going to need $209,000 a year at retirement because the cost of living has compounded 3 percent every year. People forget the inflation factor when looking at what they may need," said Ben Doty, senior investment director at Koss Olinger & Co. in Gainesville, Florida.

Consider that you might live to 100. How much will you need for every year of retirement?

Start by considering how much you want to spend in retirement each year, and think about what age you'd like to retire. If you want to retire at 65 and live until 100, that would be 35 years of living times how much you want to spend. Then add on 3 percent per year, plus medical expenses. For example, a 65-year-old couple retiring will need at least $240,000 to cover future medical costs, according to a study by Fidelity Investments.
"Basic retirement calculators can help you determine how much you need to put aside to reach your target nest egg given your age," Doty says.

Myth: A 401(k) is the best place for your retirement savings, even without a matching program. Other retirement plans, like IRAs, may provide more benefits than a 401(k), so it's best to do your research. "Those extra contributions can potentially be put to better use in places that provide more benefits, safety and liquidity, and possibly at a lower cost," says Richard Bavetz, investment advisor for Carington Financial in Westlake Village, California.

Find out if your 401(k) and 403(b) are providing a match to your contributions. "If an employee's contributions are not matched, then the only advantage to making these contributions is going to come from the tax strategy if taxes are lower when the employee starts withdrawing their savings. If taxes are the same or higher, then there is no advantage and potentially an even higher tax liability if taxes rise," Bavetz says.

Myth: You will be in a different tax bracket when you retire. Some think that because they won't have a job when they retire (isn't that the purpose of retiring?), their income will be zero. Not true. You are usually taxed on how much you withdraw from your retirement savings. If you withdraw $60,000 per year from your 401(k) as a single person, you'll pay 25 percent taxes on it, as if it was your salary. Some people who are great at saving, and others who retire with pensions, get pushed into a higher tax bracket when they retire and withdraw from their funds.

"Earning the same or slightly more in retirement is very attainable if a person has good saving habits, can be consistent and is given the proper guidance. In fact, I might even go so far as to suggest that if a financial planner is telling their clients to plan for a lower bracket, they ought to be fired," Bavetz says.

Myth: Your 401(k) is free. While your employer does pay the majority of costs to run the plan, it definitely isn't free for employees. Many providers will charge a monthly per-participant flat fee, says Andrew Meadows, vice president of brand and culture at Ubiquity Retirement + Savings in San Francisco.

"There are also asset-based fees, which can be as high as 2 percent, to pay for the management of the funds in which the employee is invested," Meadows says.

To review your 401(k) plan management expenses, ask for an example of a fee report that a typical client would get. "There will be two," Meadows says. "One for the regular recurring cost of administration and the one that comes from the investments. The latter is likely hidden, but due to fee disclosure regulations, a provider must share this with their client."

Myth: Your 401(k) doesn't need any analysis. It's on autopilot. You have different investment options in your 401(k), and some are better than others. And you've heard the expression, "don't put all of your eggs in one basket." It's the same for your retirement.

Michael Sander, vice president for the Creative Planners Group in Tarrytown, New York, sees people make three major mistakes when they allocate their 401(k) investments: They put all their funds in money market or stable value funds, they pick only the fund that had the best return in the prior year or they use only a target-date fund.

"Many target-date funds do not have the most optimized asset allocations available compared to a well-structured portfolio utilizing many diversified funds. Often, target-date funds underweight small caps, international holdings and the mixture of stocks and bonds is more or less than what is intended," Sander says.

Different funds offer different benefits, Cox says. "Participants need to understand that a single fund can be more diversified than 20 funds," he says. Start by checking the number of underlying holdings in each fund to get a rough estimate of how diversified the fund is, he says.

If you're overwhelmed, you can always hire a fiduciary service to manage these for you through a well-known company, Meadows says. A fiduciary must, by law, make decisions that are only in your best interest. "If you're not investment-savvy, these companies have great reputations and will take responsibility for ensuring you and your employees are making the most out of your investment options," Meadows says.

Also, it's a good idea adjust your 401(k) contributions and investment strategy – when you get a sizable bonus or a great promotion, you may want to increase your contribution amount, Meadows says.

Most plans come with advice, but people don't ask for it. A recent Charles Schwab survey found that only about 12 percent of participants are getting professional advice for their 401(k), even though nearly half say they'd expect better performance if they used advice.

"Don't let daily market swings dictate your investing decisions," says Catherine Golladay, vice president of 401(k) Participant Services at Charles Schwab. "Just because a specific fund is underperforming today doesn't mean it will be doing poorly tomorrow, or vice versa. You should develop a strategy based on your personal situation and risk tolerance, then stick with it. Use this time to make sure you are taking advantage of important plan features like professional investment advice."