Don’t Bother With That High Cost 401(k)

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Rick Ferri
Posts: 8597
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Don’t Bother With That High Cost 401(k)

Post by Rick Ferri » Mon Mar 17, 2014 9:01 am

A 401(k) plan is broken when the fund expenses overwhelm the tax benefit of participation. Employer sponsored 401(k) and similar tax-deferred savings plans encourage employees to save for retirement by deferring income taxes on their contributions. However, a recent study suggests that about 1 in 7 plans provide investment options that are so expensive that young workers would be better off not participating. They would be better off paying taxes and investing after-tax in low-cost index funds.

There have been several articles in the press about this study including a recent one by Larry Swedroe. Here is mine take in it: Don’t Bother With That High Cost 401(k)

Rick Ferri
Last edited by Rick Ferri on Mon Mar 17, 2014 10:38 am, edited 1 time in total.
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.

Bob's not my name
Posts: 7405
Joined: Sun Nov 15, 2009 9:24 am

Re: Don’t Bother With That High Cost 401(k)

Post by Bob's not my name » Mon Mar 17, 2014 9:06 am

Young workers change jobs and roll over.

Jack FFR1846
Posts: 7970
Joined: Tue Dec 31, 2013 7:05 am

Re: Don’t Bother With That High Cost 401(k)

Post by Jack FFR1846 » Mon Mar 17, 2014 9:16 am

Can someone ballpark what is considered a pivotal rate, above which it's not worth being in the plan?

My 401k has high fees (lowest cost plan is just south of 1.25%) but I expect that soon enough I'll leave or retire and then roll it all out, so I'm out 5 or 6 years of these fees while reducing my taxes in these income years.
Bogle: Smart Beta is stupid

User avatar
tfb
Posts: 7972
Joined: Mon Feb 19, 2007 5:46 pm
Contact:

Re: Don’t Bother With That High Cost 401(k)

Post by tfb » Mon Mar 17, 2014 9:23 am

Rule of thumb is 30 divided by the number of years. The expense has to be 5% if you are out in 6 years.

Median tenure for age 25-34 is 3.2 years. Do bother with that high cost 401k.

http://www.bls.gov/news.release/tenure.t01.htm
Harry Sit, taking a break from the forums.

Jeff7
Posts: 329
Joined: Sat Nov 24, 2012 2:30 pm

Re: Don’t Bother With That High Cost 401(k)

Post by Jeff7 » Mon Mar 17, 2014 9:27 am

tfb wrote:Rule of thumb is 30 divided by the number of years. The expense has to be 5% if you are out in 6 years.

Median tenure for age 25-34 is 3.2 years. Do bother with that high cost 401k.

http://www.bls.gov/news.release/tenure.t01.htm
Wow. Not long at all.
(32yrs old here, and I've been with this company.....it'll be 5 years this year.)

I wonder if they have anything that does more of a breakdown of the data, by job type? (Professional versus entry-level retail, that sort of thing.)

User avatar
tfb
Posts: 7972
Joined: Mon Feb 19, 2007 5:46 pm
Contact:

Re: Don’t Bother With That High Cost 401(k)

Post by tfb » Mon Mar 17, 2014 9:32 am

Jeff7 wrote:
tfb wrote:Rule of thumb is 30 divided by the number of years. The expense has to be 5% if you are out in 6 years.

Median tenure for age 25-34 is 3.2 years. Do bother with that high cost 401k.

http://www.bls.gov/news.release/tenure.t01.htm
Wow. Not long at all.
(32yrs old here, and I've been with this company.....it'll be 5 years this year.)

I wonder if they have anything that does more of a breakdown of the data, by job type? (Professional versus entry-level retail, that sort of thing.)
You see more tables if you click on the Table of Content link at the bottom.
Harry Sit, taking a break from the forums.

YttriumNitrate
Posts: 1062
Joined: Tue Mar 26, 2013 12:13 pm

Re: Don’t Bother With That High Cost 401(k)

Post by YttriumNitrate » Mon Mar 17, 2014 9:43 am

It seems the author of that paper overlooked some of the key benefits of a 401(k) to come up with that 1 in 7 number.

1. Funds in a 401(k) are not counted against a college financial aid calculation.
2. Funds in a 401(k) are more protected against judgements than funds in a taxable account.

BradMajors
Posts: 396
Joined: Sun Mar 18, 2007 1:56 pm

Re: Don’t Bother With That High Cost 401(k)

Post by BradMajors » Mon Mar 17, 2014 10:05 am

If you are contributing less than the IRA contribution limit, it is almost always better to not participate in your 401(k) and contribute to an IRA instead.

Riverstwo
Posts: 214
Joined: Mon Feb 04, 2013 2:42 pm

Re: Don’t Bother With That High Cost 401(k)

Post by Riverstwo » Mon Mar 17, 2014 10:29 am

What about the big reason to stay in a 401K....company match?

Also, many 401Ks have Stable Value Funds, protecting the principal at least!

columbia
Posts: 987
Joined: Tue Aug 27, 2013 5:30 am

Re: Don’t Bother With That High Cost 401(k)

Post by columbia » Mon Mar 17, 2014 10:34 am

In this context, what ER is too expensive?

User avatar
ogd
Posts: 4854
Joined: Thu Jun 14, 2012 11:43 pm

Re: Don’t Bother With That High Cost 401(k)

Post by ogd » Mon Mar 17, 2014 10:37 am

Rick: what do you think about putting money in then immediately going on the offensive to advocate for a few index options? To me that's a better avenue than foregoing the 20K / year tax deferral forever. There's no guarantee of success, but it's a good possibility as the awareness of the effects of fees seems to be growing.

User avatar
Rick Ferri
Posts: 8597
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Re: Don’t Bother With That High Cost 401(k)

Post by Rick Ferri » Mon Mar 17, 2014 10:44 am

A few thoughts on the study:

1) The economics change completely if there is a company match.
2) The benefit of tax-deferral may be higher by qualifying an individual for other tax benefits due to lower income.
3) A plan may have index funds that are not being utilized enough, which counted against the plan in the study. That's an education issue.
4) The study used 2009 data. Some plans have become more responsible since then.

Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.

Bob's not my name
Posts: 7405
Joined: Sun Nov 15, 2009 9:24 am

Re: Don’t Bother With That High Cost 401(k)

Post by Bob's not my name » Mon Mar 17, 2014 11:13 am

Employee bad choices were also part of the problem studied. We like to talk about employees making bad 401k choices, but not so much about people making bad choices with credit cards, home purchases, car purchases, tickets for sporting events, lottery tickets, legal alcohol consumption, brokers, real estate agents, off-road vehicles, skateboards, tattoos, grizzly bear photography, and swimming pool stunts.

4th and Inches
Posts: 166
Joined: Mon Nov 12, 2012 8:53 pm

Re: Don’t Bother With That High Cost 401(k)

Post by 4th and Inches » Mon Mar 17, 2014 11:22 am

The cheapest fund in my 401k other than money market is PTRAX with an expense ratio of .71% and an administrative fee of 1.25% tacked on for a grand total of 1.96%. The 1.25% administrative fee applies to all funds in the plan. PTRAX is where I have nearly all of my portfolio's bond holdings.

My company provides a 4% match when I chip in 5%. That is all I am doing for now and I am 100% vested in the company match. I believe that it still makes total sense to invest up to the company match and then fill other investment options (My wife's solid 403b, our Roth IRAs, no major debt) before funding up to the IRS limit on my 401k.

I believe my logic is correct, but what about when I can afford to fill my 401k to the IRS max? I don't plan to work at my current employer for more than 5 years.

Bob's not my name
Posts: 7405
Joined: Sun Nov 15, 2009 9:24 am

Re: Don’t Bother With That High Cost 401(k)

Post by Bob's not my name » Mon Mar 17, 2014 11:32 am

tfb wrote:Rule of thumb is 30 divided by the number of years. The expense has to be 5% if you are out in 6 years.

User avatar
White Coat Investor
Posts: 13541
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Don’t Bother With That High Cost 401(k)

Post by White Coat Investor » Tue Mar 18, 2014 5:54 am

BradMajors wrote:If you are contributing less than the IRA contribution limit, it is almost always better to not participate in your 401(k) and contribute to an IRA instead.
Unless there's a match....

Or you're in a state where 401(k) money gets better asset protection than IRA money....

or you make too much to deduct the IRA contribution.....

or your 401(k) has particularly low costs.....

or your 401(k) has unique investments like the G fund or a stable value fund.....

or you would like to borrow from your retirement account.....

Oh wait, maybe it isn't almost always better to not participate in the 401(k).

Just teasing, but I think you overgeneralized a little too much on this one.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

Scandium
Posts: 54
Joined: Wed Dec 18, 2013 9:05 am

Re: Don’t Bother With That High Cost 401(k)

Post by Scandium » Tue Mar 18, 2014 8:06 am

I managed to get my total 401k ER down to 0.7% which I consider not great, but not that bad. So I think I'll keep contributing to it (I'm 31 y.o).

I have two funds in the 0.6% range and a couple that are higher, mostly for the bonds which are 0.7-0.9. Allocation is a mess because of limited choices, but I can live with it.

4th and Inches
Posts: 166
Joined: Mon Nov 12, 2012 8:53 pm

Re: Don’t Bother With That High Cost 401(k)

Post by 4th and Inches » Tue Mar 18, 2014 8:25 am

Bob's not my name wrote:
tfb wrote:Rule of thumb is 30 divided by the number of years. The expense has to be 5% if you are out in 6 years.
I imagine that is assuming no company match. Correct?

User avatar
Artsdoctor
Posts: 3564
Joined: Thu Jun 28, 2012 3:09 pm
Location: Los Angeles, CA

Re: Don’t Bother With That High Cost 401(k)

Post by Artsdoctor » Tue Mar 18, 2014 9:46 am

There have been some changes since 2009. Plans are now required to put a cash figure on administrative fees in an effort to provide more transparency; I can't speak for all plans, but this has succeeded in bringing SOME costs down (although not enough). Additionally, the tax benefits now are greater for high-income earners since federal (and state, in some instances) marginal rates have increased substantially.

A match was excluded from the study. It is always better to take the match than leave that money on the table.

User avatar
abuss368
Posts: 12974
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!

Re: Don’t Bother With That High Cost 401(k)

Post by abuss368 » Tue Mar 18, 2014 9:51 am

Hi Rick,

Excellent article. Thank you for posting.

At what point, in terms of an expense ratio, does the 401(k) not become beneficial and taxable investing does? 1.00%, 1.25%, etc?

Best.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

Bob's not my name
Posts: 7405
Joined: Sun Nov 15, 2009 9:24 am

Re: Don’t Bother With That High Cost 401(k)

Post by Bob's not my name » Tue Mar 18, 2014 9:59 am

grabiner wrote:My rule of thumb is that if the product of the expenses and the years you will be in the plan exceeds 30%, then a taxable stock investment may be better.
In other posts grabiner has clarified that "expenses" means the differential vs. what you can get at Vanguard.

Angst
Posts: 1850
Joined: Sat Jun 09, 2007 11:31 am

Re: Don’t Bother With That High Cost 401(k)

Post by Angst » Tue Mar 18, 2014 11:08 am

It's important that people with such poor investment options in their 401(k) accounts be aware of the consequences. Great article, if a little depressing. I would suggest however that one of the most important lessons that needs to be communicated is that people need to "bother" with their 401(k) accounts, that is, they ought to try to get them changed. If no one complains, surely nothing will change. I'd refer them to the wiki pages covering this subject: http://www.bogleheads.org/wiki/How_to_c ... 01(k)_plan

User avatar
hoppy08520
Posts: 2007
Joined: Sat Feb 18, 2012 11:36 am

Re: Don’t Bother With That High Cost 401(k)

Post by hoppy08520 » Tue Mar 18, 2014 6:26 pm

I'm a big a critic of bad 401(k) plans as anyone can see by scanning though my posts. But I think the "1 in 7 plans" statistic is a bit sensationalistic. I think it would be more interesting to know the percentage of participants in a bad plan.

There is a strong correlation between the quality of the plan and the size of the company, measured in number of participants and sum of assets under management.

IBM and Boeing, for example, have great 401(k) plans, but a small company often doesn't have the clout, motivation and assets to bargain for a good plan so their employees get a crappy plan. IBM and Boeing have hundreds of thousands of employees (200,000 enrolled in IBM and 220,000 enrolled in Boeing according to Brightscope), and that small company with the bad plan may just have 10 employees.

So, to say that 1 in 7 plans might be bad doesn't really mean much if the "1" in that 7 is a small furniture store and the other 6 include an IBM. In this case, you're looking at a ratio of more like "1 out of 25,000 participants" have a bad plan.

manwithnoname
Posts: 1584
Joined: Mon Jul 22, 2013 7:52 pm

Re: Don’t Bother With That High Cost 401(k)

Post by manwithnoname » Wed Mar 19, 2014 9:16 am

hoppy08520 wrote:I'm a big a critic of bad 401(k) plans as anyone can see by scanning though my posts. But I think the "1 in 7 plans" statistic is a bit sensationalistic. I think it would be more interesting to know the percentage of participants in a bad plan.

There is a strong correlation between the quality of the plan and the size of the company, measured in number of participants and sum of assets under management.

IBM and Boeing, for example, have great 401(k) plans, but a small company often doesn't have the clout, motivation and assets to bargain for a good plan so their employees get a crappy plan. IBM and Boeing have hundreds of thousands of employees (200,000 enrolled in IBM and 220,000 enrolled in Boeing according to Brightscope), and that small company with the bad plan may just have 10 employees.

So, to say that 1 in 7 plans might be bad doesn't really mean much if the "1" in that 7 is a small furniture store and the other 6 include an IBM. In this case, you're looking at a ratio of more like "1 out of 25,000 participants" have a bad plan.
Large companies have enhanced their 401k plans because they have eliminated the financial drag of a retirement plan on their balance sheets and used part of the saving to provide a better 401k plan. IBM terminated its cash balance retirement plan about 10 years ago after engaging in costly litigation over whether it was legal. (It was). IBM used part of the saving to create private label funds with a generous match for its 401k plan which had over $41B in assets as of the end of 2012. According to one blog the average fee for the 205 funds is .44% which is not exactly cheap.

https://www.futureadvisor.com/401k/inte ... orporation

In 2012 IBM began making its match only once a year to save money. Even the best plans are cutting costs.

Boeing is terminating its DB plan for non union employees at the end of 2015 and will shift to a 401k plan. Again its a cost saving for the employer.

There is no free lunch for employees in corporate retirement plans.

JustMe
Posts: 20
Joined: Thu May 31, 2012 11:18 am

Re: Don’t Bother With That High Cost 401(k)

Post by JustMe » Wed Mar 19, 2014 10:33 am

manwithnoname wrote:IBM terminated its cash balance retirement plan about 10 years ago after engaging in costly litigation over whether it was legal. (It was). IBM used part of the saving to create private label funds with a generous match for its 401k plan which had over $41B in assets as of the end of 2012. According to one blog the average fee for the 205 funds is .44% which is not exactly cheap.
The .44% average is misleading. IBM divides its available funds into 4 categories:
1. Life Cycle (e.g. target date and life strategy funds).
2. Core Funds (e.g. total stock, total bond, inflation-protected bond, total international, REIT).
3. Expanded Choice (slice and dice, e.g. emerging market/European/Pacific stock, large/small cap growth/value, IBM stock, long-term corporate bond, etc.)
4. Mutual Fund Window (various PIMCO, Fidelity, Vanguard, Dodge & Cox, DFA, and American Funds)

In general, the mutual fund window choices are significantly more expensive than the other 3 categories. When I average across just the Life Cycle, Core Funds, and Expanded Choice, the average expense ratio is 0.12%. When I include all ~200 funds available the average ER is 0.45%.

BradMajors
Posts: 396
Joined: Sun Mar 18, 2007 1:56 pm

Re: Don’t Bother With That High Cost 401(k)

Post by BradMajors » Wed Mar 19, 2014 7:21 pm

EmergDoc wrote:
BradMajors wrote:If you are contributing less than the IRA contribution limit, it is almost always better to not participate in your 401(k) and contribute to an IRA instead.
Unless there's a match....

Or you're in a state where 401(k) money gets better asset protection than IRA money....

or you make too much to deduct the IRA contribution.....

or your 401(k) has particularly low costs.....

or your 401(k) has unique investments like the G fund or a stable value fund.....

or you would like to borrow from your retirement account.....

Oh wait, maybe it isn't almost always better to not participate in the 401(k).

Just teasing, but I think you overgeneralized a little too much on this one.
Do you know what the term "almost always" means?

BTW. There is no limit on how much you can make and still be able to make a tax deductible contribution to an IRA.

cherijoh
Posts: 4960
Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: Don’t Bother With That High Cost 401(k)

Post by cherijoh » Wed Mar 19, 2014 7:44 pm

BradMajors wrote:
BTW. There is no limit on how much you can make and still be able to make a tax deductible contribution to an IRA.
I'm afraid there is a limit if you are eligible for a company sponsored retirement plan. And since the thread is about when not to participate in your 401k, that is a given.

From IRS Pub 590:

What's New for 2014

Modified AGI limit for traditional IRA contributions increased. For 2014, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified AGI is:

•More than $96,000 but less than $116,000 for a married couple filing a joint return or a qualifying widow(er),
•More than $60,000 but less than $70,000 for a single individual or head of household, or
•Less than $10,000 for a married individual filing a separate return.

If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work, but you are not, your deduction is phased out if your modified AGI is more than $181,000 but less than $191,000. If your modified AGI is $191,000 or more, you cannot take a deduction for contributions to a traditional IRA.

placeholder
Posts: 3958
Joined: Tue Aug 06, 2013 12:43 pm

Re: Don’t Bother With That High Cost 401(k)

Post by placeholder » Thu Mar 20, 2014 3:29 pm

If you don't participate at all in the plan you'll probably be designated as not covered.

Novine
Posts: 1164
Joined: Mon Nov 17, 2008 9:07 pm

Re: Don’t Bother With That High Cost 401(k)

Post by Novine » Thu Mar 20, 2014 8:00 pm

IRS answer on whether you are covered or not.

Post Reply