For many people, the money in their employer-sponsored retirement savings plan—a 401(k) or something similar—represents a big chunk of their total savings. Even for those who have put away a considerable amount in other accounts and may own real estate and other assets, the money in a 401(k) is part of a multi-pronged effort to save enough to support your desired lifestyle in retirement and perhaps leave a financial legacy.
You may think, “that’s obvious–why bother pointing that out?” Here’s why: too often, people do not discuss their 401(k) choices with their financial advisor. It’s as though the 401(k) exists in its separate universe, apart from your “other money.” It doesn’t – your 401(k) is a component of an overall financial plan and should be viewed that way. Here are three big reasons to review your 401(k) with your financial advisor:
#1 – Objective investment advice.
A 401(k) plan administrator provides information about the funds available through the plan and maybe some examples of “typical investors.” Still, that administrator cannot make specific recommendations or give investment advice. Some of the funds in the plan may charge fairly high fees; others may charge very low fees. You may not be comfortable assessing whether or not those fees are justified (lower is usually, but not always better). People often compare the performance of their 401(k) accounts to their other investments. However, differences in allocations, investment timing, etc., often make such comparisons unreliable. Your financial advisor can help you to sort through that, evaluate the investment options available through the plan, and recommend which ones to use to achieve an optimized mix of investments. That leads us to…
#2 – Personalized advice based on your situation.
First things first – should you participate in your 401(k) Plan? Your advisor can help you to decide based on your situation. In general, we prefer not to leave free money on the table. In other words, assuming the employer matches 401(k) contributions up to a certain amount, it usually makes sense to contribute enough to get those matching funds. Beyond that, several factors may come into play, including your age, other income, your tax bracket, and your need for liquidity.
For example, imagine you are in the early stage of your career and are hoping to buy a house in the next couple of years. If you do not have enough put away for a down payment, it may make sense to limit your 401(k) contributions to the “matching amount” and put the remainder of what you could have contributed into a “save for a down-payment” high-yield savings account. You will forgo some tax savings, but the flexibility and liquidity you gain may be your best choice. Your advisor can help you think this through. If your 401(k) Plan has a Roth option, it may be better for you to choose that instead of making the pre-tax contributions as you are in a lower tax bracket right now.
On the other hand, if you are in a high marginal tax bracket, you may want to maximize your tax-deferred savings, which means contributing the maximum to your 401(k) rather than putting more money in a taxable savings account, even if you have to pay the penalty for withdrawing funds before you are 59 ½ (note that withdrawing 401(k) funds to buy your first home is an allowed exception, without penalty). As you can see, this can get complicated. It’s not something a 401(k) Plan administrator can help you decide, but your financial advisor can.
Asset Allocation Advice
What mix of stocks and bonds should you choose in your 401(k)? Asset allocation decisions depend heavily on how many years you have before you plan to retire and whether you can get a good night’s sleep if you have most of your retirement savings in stocks and the market is gyrating. Target date funds that gradually decrease the percentage of investments held in equities as your retirement date approaches are popular 401(k) choices but may not be right for you.
When you are fairly young (in your 30s and 40s), a target date or “glide path” fund will be heavily tilted toward stocks, which may not be a good fit for your risk tolerance. Even though objective evidence may show that, over the long run, you would be financially better off with a higher equity allocation, the best portfolio for you is the one that allows you to sleep well at night. If you cannot tolerate market volatility and are likely to pull your money out of the market when the going gets rough. In that case, the downside risk is much bigger than maintaining a lower allocation to equities over the years.
Conversely, a glide-path fund may be too conservative as you approach retirement age. If you have a paid-for house and other savings that will generate enough income to meet your daily living expenses in retirement, you may want to keep most or all of your 401(k) in equities. When you reach age 72, you must start taking the required minimum distributions from the account, but it may make sense for you to have only a small allocation to short-term bonds to make those withdrawals, keeping the rest in equities. A financial advisor can help you to make that assessment.
#3 – Choosing whether to convert, roll over, or stay put.
To be clear, we’re not talking about changing your religion here! We’re talking about the possibility of converting some of your Traditional/Rollover IRA or 401(k) plan savings to a Roth IRA or 401(k) if that option is available to you and what you should do with the money in your 401(k) or SIMPLE IRA account when you leave a job?
First – should you convert? A Roth conversion may make sense if you are in or below the 24% income tax bracket. You could transfer a certain amount of pre-tax money from your 401(k) or IRA into a Roth account. This will create a tax bill now but could be a big net tax win since you will never owe taxes again on that money. It will grow unencumbered from taxation and come out late in life without any taxation. Depending on your estimated tax rate in retirement, you can estimate a break-even period/age for conversions. Your financial advisor should be able to complete the calculations to determine how much sense this maneuver makes or not for your situation.
If you are already retired, it probably makes sense to roll your 401(k) money into a traditional IRA so that you can choose to invest in whatever funds you like instead of being stuck with the 401(k) plan’s line-up of funds. Remember that the funds available are frequently more costly (primarily, higher expense ratios), so the plan provider can both recoup their costs and make a profit. Of course, a rollover does not make sense for everyone. We worked with one couple that was retiring at a fairly young age. We collectively concluded it made the most sense to keep the money within the 401(k) plan but shift the investments completely into low-risk bonds since they would be drawing on the portfolio’s income over the next two years to fund specific goals along with their normal living expenses since. This maneuver was only possible because of the “Rule of 55”, a rather obscure IRS policy. Examples like this are why it’s great to have a trustworthy expert in your corner.
In all cases, sharing the 401(k)’s Summary Plan Description (SPD) with your advisor is a good idea. The SPD is the plan’s governing document and would provide answers to technical questions you might have. For example, the SPD would be useful if you have a profit-sharing plan in which the employer contributes more than the typical 401(k) match, and those contributions vest on a particular schedule. If you decide to take a different job, it would be good to review that vesting schedule before you make a move—if the profit-sharing is going to vest in a few weeks, you might delay your departure to capture some additional contributions.
To Summarize
Decisions regarding your 401(k) assets should consider not only the existence of your other investments, your comprehensive life and financial picture. Warning: there is frequently a potential conflict of interest here, depending on how you pay your advisor. Advisors who are paid a percentage of the total assets managed often do not want to spend time looking at 401(k) options. Why? Because the 401(k) is not included in “assets under management,” so an advisor who charges on that basis has little incentive to spend time optimizing your 401(k) situation. Furthermore, they are incentivized to do things like have you transfer money from your old 401(k) into an IRA under their management instead of the new 401(k) when you take a new job — which would allow for backdoor Roth IRA contributions to be made. Fee-only advisors like Gold Medal Waters do not have this conflict. Our objective is to guide you in using your money to reach your objectives, whether that money is in a 401(k), an IRA, a taxable brokerage account, or stashed under the mattress (just kidding, don’t do that). Contact us to discuss your 401(k) and any other aspect of your financial life.
