Not long ago, the television show 60 Minutes asked this question: What kind of retirement plan allows millions of people to lose 30-50% of their life savings right near retirement? The answer: Your 401-k!
What’s wrong with the 401-k?
In a nutshell, you can get wiped out. A lifetime of savings can be cut in half in a very short time. If this happens before you retire it will change your retirement plans immensely. You’ll either have to work longer to rebuild your portfolio or you’ll be forced to retire with a smaller lifestyle and less security. If this happens after you retire you may have to return to the workforce (think Wal-Mart greeters or flipping burgers) or you could possibly run out of money before you run out of life!
How could this be? Isn’t the 401-k the great accumulation vehicle to save and grow a nest egg for retirement?
The 401-k does have a lot going for it. It’s easy to participate with money being deducted from your paycheck before taxes and before you see it in a relatively painless manner. Then there are employer matches that create growth automatically. Finally, your money grows tax-deferred over a long period of time and one day you look up and you’ve got a nice nest egg for retirement.
Here though are the major problems with 401-ks.
Most 401-k plans have a very limited menu of investments to choose from that make it very difficult to diversify effectively. As a matter of fact, the menu of investments in your 401-k contains basically two flavors; risk or a money market fund. Even bond funds and target-date funds now have a significant degree of risk going forward from here. (See my post The Death of Bonds).
Another major problem is the lack of professional management. Sure the individual funds have professional management within them, but who is managing the fund selection for your portfolio? Professional managers don’t manage 401-k plans because the plans do not allow the deduction of fees to compensate the managers, so you are on your own.
So, if you are 5 to 10 years from retirement in many cases your largest retirement asset is a bundle of risk without professional management. What you are relying on is hoping that the market doesn’t have a major correction. As someone once taught me, hope is a four-letter word. If you were planning on retiring during the last 15 years you were in trouble. In 2001 and 2002 401-k plans (not counting contributions) lost 40 to 60% of their value. In 2008 and early 2009 they lost 40 to 60% again and it took 4 to 5 years to recover. That’s like going for a walk through the woods and falling in a hole that takes 4 to 5 years to climb out of. It feels great to see sunshine again but you’ve made no progress during that time! You’re just getting back to break-even.
So, how do you protect yourself and your coming retirement lifestyle?
Very, very few people know of a clause within most 401-k plans that allow for something called an in-service distribution. What this clause allows you to do, if you are 59 ½ or older, is to roll over the monies within your 401-k into an IRA while you are still working and still continue to participate in your plan. This can be done with no tax consequences and at no cost.
In other words, you can move these monies into an IRA where you now have a world of choices from which to diversify away a lot of risks and where you can have professional management of what’s often your largest retirement asset. You can manage your risk much more effectively and begin creating income to supplement your Social Security for your coming retirement. You can continue making contributions to your 401-k plan, continue receiving employer matches and continue to grow your monies on a tax-deferred basis while having protected the bulk of your retirement assets. So while you have refocused the bulk of your assets toward risk-protected growth and income, you can continue accumulating more assets in your 401-k!