Improving Retirement Plan Participant Decisions: Common Mistakes You Should Seek to Prevent
By Todd Kading, CFP®,ChFC®, Managing Director of LeafHouse Financial Advisors.
As a retirement plan sponsor and fiduciary, part of your responsibility is to help your participants make better choices when it comes to their plan investments. Before we talk about exactly how to help participants make better choices, I'd like to go into why you should be doing so, and what type of benefits you can expect. Here are four points:
Those were some of the benefits of preventing participant mistakes. Now let's list some of the most common mistakes you should seek to prevent.
Not saving enough -- Perhaps the biggest mistake when contributing to a retirement plan is simply not putting in enough money. The other problem is simply not contributing at all. According to the 2014 PLANSPONSOR Participant Survey, a dismal 29% of Americans have saved less than $25,000 in their retirement accounts. It doesn't matter if you get excellent returns if you don't have any principal.
Not tax diversifying -- Most people invest all of their money on a tax-deferred basis, refusing to make Roth contributions. Those with lower incomes pay no or close to no federal income taxes. Deferring very little tax now is not as wise as paying the very small amount now to guarantee no tax on the growth later. Also, very high income earners might benefit in adding some money to the Roth 401k because they likely do not qualify to do so in an IRA.
Investing bedlam -- Many retirement plan participants have improper asset allocation. Some think diversification is contributing an equal amount to each fund offered. Some simply pick the highest performing funds from last quarter, year, 3 year, etc. Many also have no idea what their actual risk tolerance and return needs actually are. For 401k participants nearing retirement, the Employee Benefit Research Institute found that about 38% of these investors had 80% or more in equities. This could be disastrous during a bear market like 2008. Participants also tend to exhibit irrational and detrimental trading behavior. Panicked selling during market downturns, chasing returns in last year's hot mutual fund, and attempts at market timing tend to be hazardous to portfolio returns.
Using the 401k as a credit card -- Some folks tap into their retirement account to meet monthly cash flow needs. This can destroy their future retirement. Not only are there interest charges and fees involved in borrowing from a retirement plan, but also potentially negative tax consequences. A retirement fund is not an ATM and it's important that your participants understand that.
Being a plan fiduciary is a tough job with a lot of responsibility and legal liability. But by following plan design best practices, you can help your employees secure a better future and give yourself and the company some benefit along the way.
This article is for general informational purposes and should not be considered tax or legal advice. Employers should always consult with their tax or legal advisors for the application of the ERISA rules to their specific situation.
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