According to the Employee Benefit Research Institute, 76% of workers offered a 401(k) or similar retirement plan at work contribute to the plan. That makes it one of the most common ways that we save for retirement, especially if there are matching contributions offered by the employer.
There are great benefits to these tax-deductible contributions and matches inside of company retirement plans, but there are also some frustrations that go along with them.
One of the biggest drawbacks of contributing to a company retirement plan is the lack of investment options. These can range from half a dozen to generally no more than 50. It makes sense that employers limit the number of options. First, they do not want to overwhelm an employee. Second, the more investment options that are added to the plan, the more it costs and employer.
The following are some ideas to better optimize the results if you have a company retirement plan at your disposal.
1. Take advantage of the in-service rollover provision if you are over the age of 59 1/2, but still working for the company
A little-known plan provision built into many company plans is the “in-service rollover provision”.
For those not familiar with it, it allows workers who are still employed with the company to be “treated” as if they are retired for the purposes of their eligibility to rollover the current balance into a self-directed IRA account.
The event is not taxable when the rollover is direct to the new financial institution. Furthermore it does not dissolve the current company retirement plan. As a result, the employee will still be eligible to make their workplace contributions and receive company matching.
Utilizing an in-service rollover has several great advantages:
Once inside the new self-directed IRA account, an investor has exponentially increases investment options. For those who want to continue to use mutual funds as they did in their company retirement plan, it now opens up a wealth of new mutual fund choices.
It also opens up new investment strategies outside mutual funds or even market-sensitive investments such those that have protection of principal or future guaranteed income.
Many employees have never heard of the option of an in-service rollover while they are still working. This is because the investment provider of the company retirement plan does not advertise it. This makes sense, if you think about it. What investment company wants to advertise that you can move all your money somewhere else?
You can find out if your plan has the in-service rollover provision by contacting the investment provider (Fidelity, T. Rowe Price, Prudential, etc) directly.
2. Find out if your company has a “Self-Directed Brokerage Window”
Depending on your company, your company retirement plan may have a 401(k) alternative called a Self Directed Brokerage Window.
It allows the participant, still inside the umbrella of the company retirement plan, to open up a separate brokerage account. These brokerage windows have many more investment options from which to choose.
For the savvy investor, more investment options equals the potential to invest smarter. Or for those who would rather delegate their investment management, several brokerage windows, including Fidelity (using BrokerageLink) and Schwab (using Personal Choice Retirement Plans) allow the participant to hire a third-party investment manager to professionally manage the brokerage window account.
3. Use your company retirement plan as a targeted piece of your total portfolio.
There are no rules stating that your company retirement plan has to be perfectly diversified.
Think of your company retirement plan as a piece of your total retirement portfolio. You most likely have multiple investment accounts including those of a spouse’s company retirement plan or other self-directed IRA accounts. If you consider all these different types of accounts as one big whole, you may be better off to use your company retirement plan for a specific allocation of that whole.
For example, your company retirement plan could be invested solely in bond funds in order to represent the fixed income portion of your total portfolio.
Be sure to monitor your company retirement plan each year to make sure it still represents the desired percentage of the whole.
4. Contribute only up to the match into company retirement plans
Because of the limited number of investment options available inside of company retirement plans, I would not recommend contributing more than the amount that the employer matches.
Most people close to retirement already have too much money trapped inside tax deferred accounts. Although the tax savings are great in the accumulation years, the tax burden will be great in the distribution years.
That is why it makes sense to diversify the type of retirement accounts you use between tax-deferred, and tax free.
Options for after-tax contributions for future tax-free income include Roth IRAs and Roth 401(k)s. If you do not qualify for a Roth IRA due to income limitations, or if you want to contribute additional funds for future tax free income, you can consider fixed-indexed or variable universal life.
Company retirement plans are a great weapon in the arsenal for those saving for retirement. With education and planning, they can be optimized to compliment your total savings strategy.