Scott Burns

Rating Your 401(k) Plan

If medals were given for 401(k) plans, how would your plan rank?

Would it be gold? Would it be silver?

Or would it be bronze or lead?

The best plan is one that takes as little as possible from the return on your savings. A plan with minimal expenses allows employees to accumulate the maximum amount of money.

The difference between an inexpensive plan and an expensive plan, as you will soon see, can be a million dollars or more.

Yes, you read that right. A low-expense plan can mean an additional $1 million or more to average workers. Suppose, for instance, that you are a 25-year-old worker earning $30,000 a year. You expect your income to increase 4 percent a year (1 percent faster than inflation), and you save 10 percent of your income.

What does your future look like?

Well, by age 67 your final salary will be $162,000. That's a nice lifetime productivity gain of $56,000 over just keeping up with inflation. Unfortunately, it also means your retirement nest egg needs to be bigger than anything you thought about at 25 or 30. If your target is 20 times your final income, it means you need to accumulate $3,240,000.

Will your plan help you or hinder you?

A worker whose savings earned 10 percent a year after nominal expenses would accumulate $2,880,000, or 17.78 years of final income. Pretty close.

A worker whose savings earned 10 percent a year before plan expenses of 1 percent would accumulate $2,213,000, or 13.66 years of final income. To live on that, you'll probably need to reduce your standard of living a bit.

A worker whose savings earned the same 10 percent a year before plan expenses of 2 percent would accumulate "only" $1,715,000, or 10.58 years of income. That's a serious reduction in standard of living.

As I said, the long-term difference can be more than a million dollars.

Significantly, even a generous employer match can't make up for excessive expenses. The same worker whose savings earned 10 percent before expenses of 2 percent would accumulate $2,572,000 if he had the benefit of a 50 percent employer match.

(Employers take note: You can do more for your employees with a low-expense plan than you can with a high match. Employees take note: If your employer is indifferent to plan expenses but generous with the match, you should look for a smarter employer.)

The federal government has established the platinum standard for 401(k) plans. It's called the Thrift Savings Plan, and it is available to all federal employees. This plan has annual expenses of 6 basis points. That's 0.06 percent. It's a tiny fraction of the costs in typical private sector 401(k) plans and a rounding error compared to the outrages that pass for plans in the 403(b) sector.

Nothing measures up against the Thrift Savings Plan.

The rest of us live in a world of gold, silver, bronze and lead -- the best and worst of what the financial services industry has to offer. How do you know if your plan ranks as gold or lead?

Here's the approach I took. Using the Morningstar mutual fund database, I rank-ordered the expense ratios of three major fund categories: balanced, domestic equity and taxable bonds. Then I found the expense ratios for least expensive 10 percent, 25 percent, 50 percent, 75 percent and 90 percent. The table below shows the distribution of expense ratios.

GRADE YOUR 401(K) PLAN����Percentile�Balanced�Domestic Equity�Taxable Bond�Rank��10�0.36%�0.63%�0.50%�Under 25 ranks Gold��25�0.78�1.00�0.74���50�1.19�1.39�1.02�50 to 25 ranks Silver��75�1.70�1.94�1.55�Over 50 but less than 75 ranks Bronze��90�2.08�2.25�1.83�Anything over 75 ranks Lead��Source: Morningstar for expense ratios, author for rankings��

I characterized plans with funds in the least expensive 25 percent as "Gold." It's about the best most large employers can do. Their expenses were under 1 percent. You'll find Fidelity and American funds plans in this group.

I characterized the second quartile -- plans with expenses between the least expensive 25 and 50th percentiles -- as "Silver." There is no reason a plan of any size should cost more.

I characterized the third quartile -- plans that were more expensive than the median -- as "Bronze." That's barely acceptable.

Anything with expenses in the bottom quartile is ranked as "Lead." These plans will do so much damage to employee retirements that a low-cost IRA will be a better choice. Many of the variable annuity products offered to public school teachers and hospital workers are in this category.


-- Information on the federal Thrift Savings Plan:

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