Like it or not — and thanks to the demise of the once-sacrosanct but now passé company pension — the 401(k) plan is the primary retirement savings vehicle today for vast numbers of American workers.
While the 401(k) plan — whether traditional or Roth, SIMPLE or Safe Harbor — is a fact of life and regular pre-tax deductions toward a plan balance figure in many employees' paychecks, a lot of people don't quite understand the fund they're paying into. In fact, there are a lot of misconceptions and myths that need clearing up.
We turned to CNBC Digital Financial Advisor Council member, certified financial planner and author Tim Maurer, currently wealth advisor and director of personal finance for Buckingham and the BAM Alliance, to help debunk 10 of the most common myths about 401(k) plans.
— By Tim Maurer, director of personal finance for Buckingham and The BAM Alliance, and CNBC's Kenneth Kiesnoski
Posted 14 July 2016
Myth: 401(k) savings are eternally tax-free.
Fact: "You — or your heirs — are going to be required to pay tax on 401(k) savings at some point, whether it's now (in the form of Roth 401(k) contributions) or later (in the form of tax-deductible traditional 401(k) contributions)," said Maurer. "You didn't think the IRS was going to be that generous, did you?"
Myth: A 401(k) plan is always your best retirement savings option — corporate match or no corporate match — beating out individual retirement accounts and other savings vehicles.
Fact: "There is no better investment than one that earns 'free money,' like in the case of a 401(k) company match," said Maurer. "But beyond the matching contribution, there may be numerous reasons why a traditional or Roth IRA — or even a liquid, taxable investment account — is a preferable savings vehicle."
Myth: 401(k) loans are an easy, low-cost way to finance emergency needs.
Fact: "401(k) loans are much more complex and restrictive than they appear at first glance," said Maurer. "Therefore, they should be a resource of last resort for savers hoping to maximize future retirement income."
Myth: Saving only up to the amount your employer will match will earn you enough to retire comfortably.
Fact: "The operative word in this myth is 'will,' because each employer-sponsored plan is different, and each saver has unique needs in retirement, but the average company contribution to 401(k) plans is 2.7 percent of employee compensation," said Maurer. "Even if we round up to 3 percent and assume the employer is matching half of an employee's 6 percent deferral, this means that the employee is saving a total of 9 percent of their pay, which, while meaningful, isn't going to earn a saver overachiever status."
Myth: You can save via a 401(k) plan free of charge.
Fact: "Exactly who bears the numerous costs of corporate retirement plans varies widely, but there are no free lunches — or 401(k) plans," said Maurer.
Myth: 401(k) plan fees are exorbitant.
Fact: "There are just about as many 401(k) fee schedules as there are 401(k) plans; some are exorbitant, but others are surprisingly reasonable," said Maurer. "Although new rules and disclosures will hopefully lead to more uniformity, each plan is separately negotiated between parties that may include custodians, carriers, mutual fund families, financial salespeople, record keepers, corporate fiduciaries and, not so 'unoccasionally,' golf buddies."
Myth: 401(k) savings plans are on autopilot and therefore don't need any management.
Fact: "An increasing number of 401(k) plans do default to options that may include automatic components designed to help investors help themselves, but you should never assume that your plan a) does have 'autopilot' options, or b) that any automatic default options are actually right for you," said Maurer. "Your corporate retirement plan doesn't know your individual destination, so don't trust an autopilot feature that may well take you somewhere else."
Myth: You'll definitely be in a different tax bracket when you retire.
Fact: "You may be in a different tax bracket when you retire, but you also may not be, and the primary determinant of whether or not that happens rests in hands other than your own," Maurer said. "Therefore, our efforts are better spent focusing on what we can control — like saving money and investing wisely — than in betting on what future tax rates will be."
Myth: 401(k) plans s offer a wide array of investment options.
Fact: "The number of investment options in 401(k) plans continues to fall, based on research that suggests savers are more likely to make these important investment decisions if the selections available to choose from aren't vast enough to be overwhelming," said Maurer. "However, fewer options doesn't necessarily equate to better options, and some plans still have a very large selection pool that demands due deliberation."
Myth: 401(k) savers should only invest in index funds because they're superior to actively managed funds.
Fact: "The vast majority of actively managed mutual funds underperform the very benchmarks they are designed to beat, benchmarks that are often emulated by passively managed index funds," said Maurer. "Therefore, while every individual investor should make an informed decision based on their unique ability, willingness and need to take risk, the weight of historical evidence suggests that most 401(k) investors will be better served by owning index funds over active funds."