Having worked as a 401k plan consultant for more than 30 years with some of the most prestigious companies in the world (e.g.; Apple, AT&T, IBM, John Deere, Northern Trust, Northwestern Mutual), I am always surprised by the simple but significant 401k misperceptions many plan participants have. Following are the most common and noteworthy 401k misperceptions:
1. The worst of all 401k misperceptions: I only need to contribute up to the maximum company match
Many participants believe that their company is sending them a message on how much they should contribute. As a result, they will only contribute up to the maximum matched contribution percentage. In most plans that works out to be only 6% in employee contributions. Many studies have indicated that participants need to average at least 15% in contributions each year. To dispel the most common of all 401k misperceptions, and motivate participants to contribute something closer to what they should, plan sponsors should consider stretching their matching contribution.
2. It is OK to take a participant loan
I have had many participants tell me, “If this were a bad thing why would the company let me do it?” Account leakage via defaulted loans is one of the reasons why some participants never save enough for retirement. In addition, taking a participant loan is a horrible investment strategy. Plan participants should first explore taking a home equity loan, where the interest is tax deductible. Plan sponsors should consider curtailing or eliminating their loan provisions to eliminate one of the most misunderstood of all 401k misperceptions.
3. Rolling a 401k account into an IRA is a good idea
There are many investment advisors working hard to convince participants this is a good thing to do. However, higher fees, lack of free investment advice, use of higher cost investment options, lack of availability of stable value and guaranteed fund investment options and many other factors make this a bad idea for most participants.
4. My 401k account is a good way to save for college, a first home, etc.
When 401k plans were first rolled out to employees decades ago, human resources staff helped persuade skeptical employees to contribute by saying the plans could be used for saving for many different things. They shouldn’t be. It is a bad idea to use a 401k plan to save for an initial down payment on a home or to finance a home. Similarly, a 401k plan is not the best place to save for a child’s education — 529 plans work much better. Try to eliminate the language in your communication materials that promotes your 401k plan as a place to do anything other than save for retirement.
5. I should stop making 401k contributions when the stock market crashes
This is a more prevalent feeling among plan participants than you might think. I have had many participants say to me, “Bob, why should I invest my money in the stock market when it is going down. I’m just going to lose money!” These are the same individuals who will be rushing into the stock market at market tops. This logic is important to unravel with participants and an area that plan sponsors should emphasize in their employee education sessions.
6. Actively trading my 401k account will help me maximize my account balance
Trying to time the market, following newsletters or a trader’s advice, is rarely a winning strategy. Consistently adhering to an asset allocation strategy that is appropriate to a participant’s age and ability to bear risk is what plan sponsors should ensure is communicated through their employee education sessions.
7. Indexing is always superior to active management
Although index investing ensures a low-cost portfolio, it doesn’t guarantee superior performance or proper diversification. Access to commodity, real estate, multi-sector bond funds and many other diversifiers is sacrificed by many pure indexing strategies. A combination of active and passive investments often proves to be the best investment strategy for plan participants.
8. Target date funds are not good investments
Most experts who say that target date funds are not good investments are not comparing them to a participant’s allocations prior to investing in target date funds. Target date funds offer proper age-based diversification. Many participants, before investing in target date funds, may have invested in only one fund or a few funds that were inappropriate risk-wise for their age.
9. Money market funds are good investments
These funds have been guaranteed money losers for a number of years because they have not kept pace with inflation. Unless a participant is five years or less away from retirement or has difficulty taking on even a small amount of risk, these funds are below-average investments. As a result of the new money market fund rules, plan sponsors should offer guaranteed or stable value investment options instead.
10. I can contribute less because I will make my investments will work harder
Many participants have said to me, “Bob, I don’t have to contribute as much as others because I am going to make my investments do more of the work.” Most participants feel that the majority of their final account balance will come from the earnings in their 401k account. However, studies have shown that the major determinant of how much participants end up with at retirement is the amount of contributions they make, not the amount of earnings. This is another misperception that plan sponsors should work hard to unwind in their employee education sessions.
Make sure you address all of these 401k misperceptions in your next employee education sessions.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to 401(k) plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at: http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.