When a 401k isn’t a good idea
By Chad on May 13, 2008 in 401k
Ok, this is my first real post, and I have decided to go right at the heart of the personal finance world…the 401k. My company’s 401k is crap, and I’m not contributing to it anymore! I know this goes against conventional wisdom, but I’m tired of getting poor returns with high expenses.
Overall, the 401k is a great idea allowing you to save in a vehicle that limits taxes, invest, and usually gives you a bonus from your employer. In my case, my company doesn’t provide a traditional match. Instead they place 3% of my salary in my 401k whether I put money in or not. Thus, I don’t need to contribute to get the match. Now you’re wondering, “What’s this idiot complaining about?”
Well, I did some calculations comparing the funds in my 401k to the gold standard of index funds at Vanguard. I compared annual expenses, historical returns and then factored in tax savings. The results weren’t pretty.
Annual Expenses
Every fund in my 401k had at least a 1% annual expense charge, with many having 2% or more. This is significantly more than the majority of Vanguard’s index funds, many of which have less than .25% annual expense charge.
Historical Returns
I then compared the historical performance of my 401k funds vs. Vanguard’s index funds. Again, I was disappointed to learn that the funds in my 401k NEVER matched or beat the index.
Tax Consequences
Using the numbers from the previous two categories, I created a spreadsheet calculating the total return with expenses and taxes taken out over 10, 20 and 30 years. The result? In the best case scenario my 401k would have the same value as the regular investment account, and in the worst case my 401k would be significantly less.
Obviously, I had to make some assumptions (future tax rates, future returns), but the math (not shown) is hard to argue. On top of that, I have and believe you can pick individual stocks and funds that outperform index funds. However, I used index funds in my calculations to prevent any overly positive return estimates.
The higher return in the taxable accounts is enough of a reason to quit feeding my 401k, but there is one more reason…the restrictions. As everyone knows, you are limited to the investment selections in your account and you have to wait until you’re 59.5 to withdraw the money (there are exceptions, but they are a pain). These limitations would prevent me from investing this money in a business or real estate, which I want to do someday, and it will prevent me from retiring early, which I definitely want to do.
Please take a look at your 401k and determine if the investment choices meet your goals. If the choices don’t meet your goals contact your human resources department and plead for better choices. Remember, if they don’t meet your goals, they probably don’t meet everyone else’s goals, so everyone is a potential ally. By the way, I tried this and it didn’t work very well, as we are a small company and they don’t have the resources to make a lot of changes to our 401k.
…above all, think for yourself.
I also have a very crappy 401k plan through my employer. I spoke to our human resources department about their choice of a management company and basically they chose the company with the lowest fees for _them_
In other words, our 401k management company charges my employer nothing to manage our accounts, but the funds charge the employees huge fees and kick-back commissions to the management company.
When I asked a representative from the management company about the situation he said, “we have to eat too”. Sure he has to eat, but I shouldn’t be paying for it if he’s not providing me a service I want.
The worst thing about it is that I can’t move my money to another management company until I leave the company. Luckily for me I have no intention of staying with this company until I retire.
So far, I’ve been maxing out my 401k contributions. I hadn’t considered stopping them just to avoid the fees. I suspect that paying the fees is better than paying the taxes for me, but I’ll run the numbers and see.
Thanks for the thought-provoking post!
Dale | May 18, 2008 | Reply
SM and Dale: most 401(k) plans are dung. Eventually I left my former place of employ and made of point of telling them that I might consider returning if they unscrew their offering (though the plan was not the primary reason for departure).
Here is something I considered that may or may not work for you: contribute the max % at the beginning of each year, front-loaded, and put it all into the lowest expense ratio short-term bond or income fund (most plans have some such offering). Hopefully it’s under 1%, but this isn’t the main point of the tactic.
After you are maxed out for the year, and perhaps have enjoyed any match from the employer (depends on specific plan, of course), announce that you are resigning for the sole purpose of rolling your 401(k) into a Rollover IRA. And let it be known that you’d be willing to return a week or two down the line after the rollover is complete. That should give you enough time later that year to re-enroll before January of the next year, when you begin the cycle again.
Obviously, you can’t do this if you are some sort of a company man / suit that depends on the income. You have to be willing to walk away and not come back if your company does not make you the same or better offer upon your return, or even better unscrew the 401(k) plan. I’ve heard of (but have seen) plans where employees are allowed to self-manage some or all of their plan assets. I pressed my former employer (HR dept) about that and the predictable answer was just “no”, a combination of laziness, ignorance, and insult that an engineer could possibly know more about 401(k) plans than the HR “subject matter experts”.
Steve Austin | May 19, 2008 | Reply
Thanks for the advice Steve. I have actually thought about doing something similar.
I’m not going to do the quick quit method, because my company contributes their part without my contribution, and it’s a good place to work.
Also, I want the money freed up for real estate and business investments.
It’s not always the company’s fault when it comes to poor 401ks. The cost of having a 401k is very high, and the better ones cost even more. The more employees a company has the cheaper the 401k per person. Thus, bigger companies (mine is small) usually have better plans. What you really should do is write your Congressmen and ask for better legislation. Why are IRA’s cheap, when 401ks are expensive to run?
Chad - Sentient Money | May 19, 2008 | Reply
Here’s cautionary tale about 401k plans. It basically points out that most people do not make the investment decisions necessary to even have a chance of retiring with a 401k.
http://money.cnn.com/2008/05/19/pf/retirement/West_virginia_pensions.moneymag
Dale | May 23, 2008 | Reply
My company does a 4% matching, and if it wasn’t for that, I wouldn’t touch it either. The returns sticking it under my mattress are better.
Christine Gilbert | May 29, 2008 | Reply