Let’s Talk About … the 401(k)

The 401(k) originally began as a company profit-sharing plan. Companies had been funding defined benefit pensions for years, but as their annual profits and stock prices experienced volatility, they looked for ways to share that burden with employees. Through profit sharing, workers made money when the company did and made less during down years. While the actual section 401(k) tax law provision came later, this plan allowed employees to defer salary contributions into a retirement account before deducting taxes and established rules to ensure the plan was available to all employees, not just executives.1

Once the 401(k)-style plan was established, it could be used to invest in more than just company stock. Instead, it was a way to put investment control into workers’ hands without limiting their retirement income prospects based on their company’s performance. By contributing to their retirement portfolio and customizing how it was invested, employees had the opportunity to out-earn previous pension benefit levels and live a fuller retirement lifestyle.2

That hasn’t proven to be the case for many workers. The shift to personal savings and investment money management hasn’t led to high levels of reliable income as pensions did.3 After all, your average worker doesn’t have in-depth investment knowledge or the time to follow the markets closely. And, unless they were willing to pay an advisor for advice, they wouldn’t get much help in this area.

This is one reason to work with a financial advisor who is willing to help you manage your entire financial picture. It’s important to ensure that any individual investment portfolio doesn’t overlap too much with 401(k) holdings so you stay properly diversified. By the same token, you should consider all of your holdings when establishing an asset allocation to help you meet your financial goals. We’re happy to evaluate your portfolio, including your 401(k) investment options. Just give us a call.

In recent years, more employers have started offering “financial wellness benefits” to help employees manage their 401(k) investments. These may involve online resources or actual advisors with whom you can consult regarding your 401(k) plan.4 However, your employer-sponsored advisor may not be able to advise you on your entire investment portfolio.

Employers used to absorb the cost of managing a pension fund, but today employees have to pay individual fees for a wealth manager to manage their 401(k), and it’s not cheap. The average fee to manage a 401(k) account is around 0.5 percent a year. Over a 40-year time span, those fees can really add up and impact total earnings.5

Despite any drawbacks, 401(k) plans often offer a benefit unlike no other investment: free money. Many employers will match worker contributions up to a certain percentage. This allows them to still contribute to their employees’ retirement savings even though they are not providing a pension plan. Recently, the IRS announced 401(k) plan contribution limits for next year. While the salary deferral amount remains the same at $19,500 ($6,500 catch-up for age 50-plus), it raised the overall contribution limit from $57,000 to $58,000 in 2021. This helps if your employer plan permits special after-tax salary deferrals, and it can benefit self-employed workers who have a solo or individual 401(k) or SEP retirement plan.6

Content prepared by Kara Stefan Communications.

1 Elizabeth Bauer. Forbes. March 7, 2020. “Fact Check: Were 401(k)s Really An ‘Accident Of History’?” https://www.forbes.com/sites/ebauer/2020/03/07/fact-check-were-401ks-really-an-accident-of-history/#7f70362f6110. Accessed Oct. 28, 2020.

2 Maryalene LaPonsie. U.S. News & World Report. July 22, 2020. “What’s the Difference Between a Pension Plan and a 401(k)?” https://money.usnews.com/money/retirement/401ks/articles/pension-vs-401-k. Accessed Oct. 28, 2020.

3 Monique Morrissey. Economic Policy Institute. Dec. 10, 2019. “The State of American Retirement Savings.” https://www.epi.org/publication/the-state-of-american-retirement-savings/. Accessed Oct. 28, 2020.

4 James Mahaney. Pension Research Council. Feb. 20, 2020. “What’s Behind the Growth of Financial Wellness Programs.” https://pensionresearchcouncil.wharton.upenn.edu/blog/whats-behind-the-growth-of-financial-wellness-programs/. Accessed Oct. 28, 2020.

5 Ethan Schwartz. Bloomberg. Oct. 8, 2020. “401(k) Fees Are Eating Your Retirement Savings.” https://www.bloomberg.com/opinion/articles/2020-10-08/401-k-fees-are-eating-your-retirement-savings. Accessed Oct. 28, 2020.

6 Ashlea Ebeling. Forbes. Oct. 26, 2020. “IRS Announces 2021 Retirement Plan Contribution Limits For 401(k)s And More.” https://www.forbes.com/sites/ashleaebeling/2020/10/26/irs-announces-2021-retirement-plan-contribution-limits-for-401ks-and-more/#76dc757f215f. Accessed Oct. 28, 2020.

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