Advanced Personal Finance

Most people know it’s a good idea to save for retirement using a 401(k). But how do you know if your 401(k) plan is a good one? Sometimes it works out to be a better idea to save elsewhere if your 401(k) sucks. How do you know if yours sucks? What does a good 401(k) look like?

For the 53% of American workers who are even offered a defined-contribution plan (of which the 401(k) is but one), it’s not always easy to tell how good theirs is.

Here are the features of a good 401(k)

• Has an employer match - the higher the better. A common employer match is something like 50 percent on the first six or eight percent. Forty-five percent of 401(k)s with a match fell into this category in 2006 according to a study by Mercer Human Resource Consulting. Bonus points - your match is in cash, not company stock.

• Has immediate or very quick vesting. ‘Vesting’ refers to how long you have to wait for the employer match to truly be yours. If you leave the company before you’re fully vested, you forfeit some or all of the matching contributions. That truly sucks, so a good plan has immediate vesting.

• Allows you to participate right away. For the life of me, I cannot figure out why some companies offer a 401(k) but won’t let new employees participate right away. I’ve seen plans that make you wait six months or more. What jackass came up with that idea? As if it’s not hard enough getting people to participate in 401(k)s. Now you have interia working against you. Even if the employee remembers to sign up, some are bound to be deterred by the decrease in take-home pay. Good plans don’t make you wait.

• Allows loans. Look, I don’t recommend 401(k) loans. But the fact is, people are more likely to participate in the plan if they have the reassurance of being able to get at their money through a loan if necessary. Since only 42% of people contribute to a 401(k) plan, any way to increase that number is a good reason. Bonus points - the plan has generous repayment rules. Often, if you leave the company while a 401(k) loan is outstanding, you have some stupid short period of time to repay the loan or it becomes a distribution. That’s bad. A truly good plan will allow a good bit of time before you must repay any outstanding loan.

• Offers a handful of high quality funds. The best 401(k)s will offer inexpensive funds, several different index funds and/or lifecycle funds, and all the major asset categories (stocks, bonds, real estate, cash). I really like lifecycle funds which allow you to choose the date closest to your target retirement date and invest in just that one fund. I think the Ron Popeil ’set it and forget it’ style is appealing. Bonus points - the plan doesn’t offer 40 different funds. Sometimes more choice is not better. This is one of those times.

• Offers a Roth 401(k) option. I think the Roth 401(k) is awesome. These are just like a Roth IRA in most respects. Roths are awesome because you fund them with after-tax dollars, but when you withdraw the money, it’s tax-free.

Probably no 401(k) plan has all of these features. But the more closely your 401(k) matches this list, the better. Saving for retirement can be hard, but having a good way to do it helps a lot.

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This entry was posted on Tuesday, October 23rd, 2007 at 10:43 am and is filed under 401(k). You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.