By Justin Pritchard, CFP ®
401k plans are powerful savings tools, and they can be a valuable employee benefit. But some 401k plans are too pricey. As a result, they may be too expensive to run, or just not worth it for employees to participate.
Before giving up on 401k plans, figure out exactly what’s causing high costs. You may have several solutions available to get your plan back on track.
Wrong Type of Plan
Sometimes, a 401k plan isn’t the right choice for your business. If you have limited (or sporadic) cash flows, or you’re not willing to pay ongoing expenses to maintain a 401k plan, evaluate less-expensive alternatives.
- You may be able to skip the annual administration costs (payments to your TPA or bundled vendor).
- Required contributions to employees may be less of a squeeze in lean years.
SIMPLE IRA: A SIMPLE plan is not far removed from a 401k, and those plans are typically less burdensome than full-blown 401k plans. You can still save a meaningful amount (pre-tax) every year, and you avoid annual testing. There are no required administration or recordkeeping fees, and participants typically pay most of the costs themselves. However, you lose several features, when compared to a 401k plan.
- After-tax (Roth) savings are not available in SIMPLE plans.
- Annual contribution limits are lower than a 401k allows.
- Advanced plan design isn’t available with SIMPLEs—everybody gets the same percentage or match.
- Vesting schedules don’t exist because these plans use IRAs.
SIMPLE IRAs require you to choose an option for contributing to employees, but the amount you give may be less costly than your 401k plan:
- 3-percent match: Dollar-for-dollar match on employee contributions, up to 3 percent of their pay
- 2-percent nonelective: Contribute 2 percent of the employee’s compensation to their account, regardless of whether or not they participate
SEP IRAs: If you like the profit-sharing feature in 401k plans, you can try a SEP instead. Those plans also allow you to contribute a percentage of each employee’s compensation (up to 25 percent) to their retirement account. Again, everybody gets the same percentage, and vesting is immediate. But with a SEP, you don’t have to contribute every year.
Payroll-deduction IRAs: Not interested in making employer contributions to accounts? You can offer payroll-deduction IRAs to employees to make it easy for them to save for retirement. With those plans, employees set aside their own pay, up to annual IRA limits, but employers don’t match or make profit-sharing contributions. The primary cost to employers is simply the time it takes to set up contributions through payroll.
There are additional rules and details, so visit with your financial advisor and CPA to verify, but this overview may get you thinking about IRA-based plans as less-expensive alternatives to 401k plans. That said, you may be able to ease the sting of starting and running a 401k plan with potential tax credits.
A 401k may be exactly what you need, but perhaps you’re working with expensive service providers. Financial advisors, recordkeepers, and third-party administrators (TPAs) have a variety of pricing models.
Sometimes you get what you pay for, so this is an area where you need to be discerning. But determining when a 401k is too expensive can be difficult.
Old habits: The traditional model of delivering 401k plans is not transparent, and it clings to old pricing structures based on product distribution. It’s hard to know how much you pay and who gets the money—even after fee-disclosure regulations forced service providers to share those details. But now, you have more options than ever to use low-priced share classes, index funds, and other approaches to keeping costs low.
Shop around: New vendors enter the 401k space regularly, and one of them may have a pricing model that fits your needs. That said, it’s critical to choose a high-quality service provider that is committed to 401k plans. You don’t want to change 401k vendors frequently, but a 401k that’s too expensive is a good reason to switch.
The good news: You might not even need to change your 401k vendor. You may be able to change your financial advisor or ask for price discounts from other service providers:
- Financial advisor: If your financial advisor is responsible for high fees, verify that you’re using the right advisor, paying reasonable expenses, and getting service.
- Recordkeeping platform: Recordkeepers may reduce pricing as your plan assets grow. But sometimes you need to nudge them. The recordkeeper is typically the company that you send funds to (and employees look at their accounts on the recordkeeper’s website).
- TPA: Depending on the TPA’s model, you may qualify for discounts or revenue-sharing offsets as plan assets increase. Ask how they get paid, and what options are available to you.
Shopping around not only saves you money—it can also help you manage your legal liability. As a fiduciary to the plan, it’s your duty to ensure that you’re paying reasonable fees and to verify that the plan is serving participants. The cheapest plan isn’t always what’s appropriate, but you need to pay attention to costs.
Who pays for your 401k plan? In some cases, employers cover all of the costs, writing checks for thousands of dollars (or more) each year to vendors. In other cases, employees shoulder the burden. Some employers decide that it’s too expensive to offer a 401k to employees unless the employees pay for it themselves—typically through high expense ratios or account fees.
Business or personal? If you’re a business owner and you also have one of the largest account balances in the plan, it may be best to have the business pay for 401k fees. Those fees may be deductible expenses for the business (ask your CPA to determine what’s possible in your situation). If you choose a plan that charges higher percentages or expense ratios instead, you end up paying the bulk of expenses anyway—but you pay out of your personal retirement savings, and you don’t get a deduction for those expenses.
A variety of options: As you evaluate 401k plans, look at fully-transparent options. Understand how the costs shift from employers to employees, and decide which makes sense for you. Don’t limit your search to one option or the other.
Plan Design and Education
Sometimes employers are shocked when they fail discrimination tests. They may need to make refunds to highly-compensated employees (HCEs) or make additional contributions to fix the problem. Those unexpected contributions contribute to the feeling that a 401k is expensive and unpredictable.
There are several ways to address those problems:
- Plan design: Set your plan up so that you don’t need to pass discrimination tests, or at least improve your chances of passing. A safe-harbor 401k plan requires modest employer contributions, but you don’t need to worry about discrimination tests. Alternatively, you can “stretch the match” to encourage employees to contribute more or use automatic enrollment to beef up participation.
- Employee education: Why aren’t your employees contributing? If they don’t understand the plan or have faith in it, they’ll pass on participating. But they undoubtedly need to save for retirement, and you might even help them with a match. With the help of licensed financial advisors (don’t take on that liability yourself), offer guidance and education. Sometimes people just need their questions answered one-on-one, and making that opportunity available can go a long way.
What Employees Can Do
If you’re an employee—not a business owner—and your 401k plan seems expensive, you may be able to help change things.
Speak up: For starters, ask your employer about the costs. Most employers are busy with numerous aspects of running a business, and they may not know that costs have gotten out of balance. Volunteer to head up a committee to shop alternatives, if that’s up your alley. But first, see if your employer is receptive to changes. Just like with the generosity of your health insurance plan and your salary level, employers may have their reasons for keeping things the way they are.
Save wisely: If changes aren’t on the horizon, do your best to save money and keep fees reasonable.
- Get the match: If your employer offers matching funds, it almost always makes sense to contribute at least up to the match. Don’t leave “free money” on the table. It’s hard to imagine an expense ratio that beats a 100 percent match.
- Save outside the plan? After you reach the match, evaluate saving in IRAs or other vehicles that may be less expensive. Don’t forget your HSA, if you’re concerned about retirement expenses. But be mindful of eligibility, annual limits, and other factors.
- Move when you can: Don’t skip saving just because you don’t like the price tag on your 401k. But be aware of when you can move funds to more reasonably-priced alternatives. For example, when you stop working for your employer, you typically have the right to transfer funds to another retirement account. Also, in-service distributions may be an option for older workers.
Disclosure: All information herein has been prepared solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading strategy.