Financial advisors generally suggest that investors saving for retirement take full advantage of their company’s 401(k) plan and similar defined contribution plans such as a 403(b). These plans make savings easy and relatively painless by allowing contributions via payroll deduction. Many employers offer a match which is essentially free money.
What if your client’s 401(k) is really subpar? Here are some retirement savings strategies to consider. (For more, see: New 2015 Contribution Limits: Advisors Take Heed.)
Focus on Best Options
Even lousy 401(k) plans generally have at least a couple of decent investment choices on their menu. Consider having your client concentrate their contributions in these options and use other investment accounts outside of the plan to round out their overall recommended asset allocation. These might include their individual retirement accounts (IRAs), a spouse’s retirement plan and their taxable investments.
Utilize Full Company Match
If the plan offers a match be sure clients contribute at least enough to receive the full match. A common match is half of all contributions up to 6% of an employee's salary. The 3% contribution from the company gives an instant 50% return on their money. Very few investment vehicles can beat this. (For more, see: 401(k) Risks Advisors Should Know About.)
If the company match is all or part in company stock this will require additional due diligence. Advisors should help their clients monitor this and advise them on diversifying away from the stock when eligible to do so. The rules vary by plan so it is wise for clients to consult with their company’s benefits department. There is no hard and fast rule about the amount of company stock that should held, but many financial experts caution against holding more than 5% to 10% of an investor's total assets here.
Everyone can contribute $5,500 ($6,500 if you’re age 50 or over) to an IRA for 2015. The ability to deduct a traditional IRA contribution will depend upon the client’s income and whether or not they are covered by an employer retirement plan. Roth IRA contributions have income ceilings that determine eligibility to contribute. Everyone can contribute to an IRA even if those contributions are to a non-deductible traditional IRA. In all cases the money in an IRA grows on a tax-deferred basis until withdrawn. (For more, see: Why Some Advisors are Shy to Convert Roth IRAs.)
Self-Employed Retirement Plans
Today it’s not uncommon for people to have a side gig in addition to their regular job. If this business is generating income clients can contribute to a self-employed retirement plan such as a SEP-IRA or a Solo 401(k). The strategy here would be to maximize contributions to this plan first and then decide how much, if anything, clients should contribute to an employer’s retirement plan. The advantage is that these and other types of self-employed retirement plans can be established at most custodians.
Another twist on this strategy would be to fully fund a self-employed plan for a spouse if he or she is self-employed. For 2015 the maximum contribution to a SEP-IRA is $53,000 which is based off of 25% of the owner’s compensation. A Solo 401(k) carries the same employee deferral limits of $18,000 ($24,000 for those 50 or over) as a company 401(k) plan plus there is the opportunity to make employer profit sharing contributions which could bring the total contributions to $53,000 ($59,000 for those 50 and over). This is a great opportunity for a financial advisor to advise their clients on the best way to go about this. (For more, see: How to Include ETFs in a Client's 401(k).)
Investing in a tax-deferred retirement plan offers many advantages but investing in a taxable account is also a valid way to save and invest for retirement. Downsides include taxable distributions from mutual funds and exchange-traded funds (ETFs) as well as dividends and interest from individual stocks and bonds.
On the other hand if investments appreciate in value they will be taxed at preferential long-term capital gains rates down the road versus as ordinary income which is the tax treatment for distributions for traditional 401(k) accounts or IRAs if rolled over. (For more, see: Top Tips for Managing Old 401(k)s.)
Helping clients determine whether to fund a subpar 401(k) and helping them look at alternative retirement savings strategies is a prime area for financial advisors to add value for their clients. The issues of the client’s tax bracket both current and their anticipated tax bracket down the road will play into this analysis. The ability to make pre-tax contributions to a 401(k) is more valuable for a client in a higher tax bracket. Likewise, the advisor needs to consider what the client’s tax situation might look like at retirement. Obviously this is at best an estimate as both their situation and the tax laws are subject to change.
Additionally, you can arm your client with questions and concerns to voice to their employer about the 401(k) offered if they are inclined to go this route. Employees should review the annual disclosures from their plan that benchmark the returns of the investment vehicles offered against appropriate benchmarks. These disclosures also include information about the investment expenses incurred by the plan participants. They are not always easy for clients to understand and financial advisors should routinely review them on behalf of their clients. (For more, see: 401(k) Risks Advisors Should Know About.)
The Bottom Line
It's generally a good idea for retirement savers to maximize their contributions to their employer’s 401(k) plan or similar workplace retirement plan. However, if your client’s plan is pretty lousy as their financial advisor you can play a vital role in helping them plot an alternative course to funding their retirement.
Options such as IRAs, self-employed retirement plans (if applicable to the client’s situation) and taxable investment accounts can all help make up at least in part for a subpar 401(k) plan. (For more, see: The Impact of 401(k) Outflows on Advisors.)