What Can You Do If Your 401(k) Is Not Very Good?

What Can You Do If Your 401(k) Is Not Very Good?

401(k)s can be a great way to save for retirement. But how do you know how good your company’s plan is? How would you go about measuring it? And, once you find out, what can you do about it?

On the measurement side, there is now a website, BrightScope.com, that rates 401(k) plans based on six components:

  • Plan costs and fees
  • Generosity of company match
  • Quality of investment choices
  • Degree of employee participation
  • Amount of salary deferred per employee
  • Account balance per employee

BrightScope reports how well your company’s plan fares across these six areas, plus utilizes this and other plan data to produce an overall plan rating between 1 (low) and 100 (high). It even compares your plan’s ratings with those in what they consider to be your company’s peer group. The information is displayed in a very easy-to-understand format. Best of all, it’s available for free!

How do they do this? Companies with 401(k)s are required to file Form 5500 with the Labor Department each year. This form details the size of the plan, the number of participants, the investments available, etc. BrightScope has created a massive database from this information combined with other publicly available data from the SEC and other sources. According to Business Week, the company currently rates about 30,000 plans, about 15,000 more than it had in its database in October.

How accurate is their rating and analysis of each plan? The biggest hurdle is just getting valid data. The data on those Form 5500s may be as much as two years out of date. And it might be riddled with inconsistencies on basic matters, such as which industrial category a company selects to classify itself. Data on fees and other elements of the institutional mutual funds created for 401(k) plans is also not easily found (unlike publicly traded funds which consumers can easily look up through websites like Morningstar.com). “The data is hard to get, and you have to make assumptions,” says Ryan Alfred, one of the company founders. “There’s a subset of plans where even if you have the data, they are un-rateable because there are too many gaps.” The other big challenge is getting the rating formula right. If BrightScope’s model proves defective, its analysis could be useless, or could even drive both participants and corporations to make decisions based on faulty assumptions.

More importantly, even if BrightScope’s plan evaluation is spot-on, is there really anything you can do about it? Should you consider quitting your job because your 401(k) is not the best?

Well, of course not. But there actually is something you can do about it. You might be able to take advantage of a little-known feature of many 401(k) plans called an in-service distribution. In fact, it applies not only to 401(k)s but other types of retirement plans such as 403(b)s, 457s, and even pensions. It gives you the ability to withdraw money from your plan and roll it over to an IRA, even while still contributing to the plan. However, there are a couple of limitations:

  • You have to be at least age 59-1/2. (You might be able to get around this limitation using IRS Rule 72(t), which allows fixed withdrawals for five years or until you reach age 59-1/2, whichever is longer.)
  • Your plan must support in-service distributions. You must read your 401(k)’s Summary Plan Description (SPD) carefully to determine if this option is available.

If your plan allows it, there are a number of good reasons to consider an in-service distribution rollover to an IRA:

  • Lower cost investment choices, particularly if you are utilizing a financial advisor with access to institutional funds.
  • Better diversification. Most IRAs provide a wide range of investment choices across virtually every asset class as compared to the limited investment options in 401(k)s.
  • More flexible beneficiary options. IRAs allow non-spouse beneficiaries to “stretch” an inherited IRA over their lifetimes. 401(k)s generally have more limited beneficiary distribution choices.

At the same time, there may be some potential disadvantages:

  • If you hold a lot of highly appreciated company stock in your 401(k), the rolling of that stock over to an IRA eliminates any ability you may have to take advantage of lower capital gains tax rates on the Net Unrealized Appreciation (NUA).
  • 401(k) and other qualified retirement plan assets are fully protected from creditors. Although IRAs now have federal bankruptcy protection, other IRA creditor protection is determined by state law, and in California is basically up to a judge’s decision.
  • Rolling over retirement plan assets into an IRA and then doing a Roth conversion from the IRA could have complications if there were any any after-tax dollar contributions in the retirement plan.

All in all, the ability to easily measure the quality of your company’s 401(k) through a website such as BrightScope.com, and the option to roll some of those funds over to an IRA if you so choose, are significant benefits to investors. Be aware of tools such as these as part of your overall retirement planning.

 

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