In the 1980s, a new type of retirement product began changing the market in the same way exchange traded funds are changing it today. These 401(k) plans, named after subsection 401(k) of the IRS code, had something for everybody. These plans relieved employers of planning for employee retirements, returning that responsibility to the employee. Equally important, employees had to pay into a 401(k) plan, taking much of the expense off of the employer. (For more information, read The 4-1-1 On 401(k)s.)

TUTORIAL: 401(k) And Qualified Plans

These plans became so popular that 60% of American workers now have a 401(k), according to the Wall Street Journal. With the first generation of 401(k)-investors set to retire, is this plan living up to the hype?

A study by the Wall Street Journal concluded that the average American's 401(k) would have to pay about $36,000 per year to maintain 85% of their median income, after taking into account social security in early 2011. These accounts don't come close to meeting that need for most Americans. In fact, according to a 2011 study done by the Center for Retirement Research, the average plan has about $149,400 at retirement, averaging out to $9,073 per year.

According to Vanguard, one of the largest providers of 401(k) plans, they now advise clients to contribute 12 to 15% of their paycheck to their 401(k), but most employees pay far less than that.

Putting a person's retirement planning back into their own hands may save the company money, but recent data proves that it isn't best for the employee. Asking somebody with little or no knowledge of investment markets to make such important decisions based on a stack of prospectuses that they don't understand, doesn't appear to be working. Thanks to the self-directed option in some 401(k) plans, there is another way for employees to maximize their 401(k) savings and ensure that their retirement needs are met. (To learn more, check out 5 Steps To A Retirement Plan.)

Self-Directed Plan
Since many employees don't understand how to evaluate mutual funds, they often go with the funds that are picked by default. The "one size fits all" approach doesn't take a detailed look at the individual's age, risk tolerance and retirement goals, so it is insufficient for most workers. This could lead to a false sense of security, where the employee assumes that the decisions made for them are sufficient to meet their retirement goals.

Because people often choose the pre-selected funds, they don't know about the self-directed option of the plan. The self-directed option allows the employee to designate a certain amount of their funds, often up to 50%, to be placed in the custody of an approved financial advisor, for investment in vehicles outside of the funds that are offered.

Because companies have to meet financial reporting requirements, they have a pre-selected list of financial advisors, but if the list includes fee-only or fee-based advisors with a track record of success, this often works to the employee's advantage. (To learn more about advisor, check out Wrap It Up: The Terms And Benefits Of Managed Money.)

First and perhaps most importantly, by allowing funds to be managed by a financial advisor, a relationship is formed, with somebody providing advice tailored to the person. Not only will they invest the self-directed funds, but that relationship also gives the employee a person who can help them maximize the allocation of their non-self-directed money. Having a trained person evaluating the prospectuses and making recommendations is far superior than electing the pre-made plans.

Secondly, this relationship would allow the financial advisor to produce a detailed report showing the person how much they will need in their retirement accounts in order to meet their retirement goals. A good financial planner should provide very detailed reports early in the person's career so they have time to meet these goals. This isn't taking place when employees sign up for their 401(k).

Finally, some 401(k) plans are filled with fund options that are high in fees and low in performance. This problem has contributed to 401(k) plans falling short of meeting retiree's goals but with only a few options available, employees are stuck with picking the best of the worst. Money allocated to the self-directed option is open to any investment options allowed by the IRS, which includes a vast offering of low or no-fee options, making the money work more efficiently. (For other options, read The Best Alternatives To A 401(k).)

Fees
Financial advisors don't work for free, so when considering investment options, add in the fees that the advisor is charging for their service. By law, they can't make future performance promises but they can tell you what percentage they're taking in annual fees.

If the advisor offers retirement planning services where they forecast "the magic number," the amount needed to retire comfortably, and they continue with consultation services throughout the relationship, paying 1 to 2% in total fees (the investments plus the advisor fees) is money well spent.

Not All in
Not all 401(k) plans offer self-directed options. The only way to find out if this option exists is to call the company's human resources or benefits department. If they have self-directed options, then ask for a list of approved advisors. Then research and/or call each of those advisors before allocating funds to the self-directed option.

The Bottom Line
In 2008, the Investment Company Institute, a trade organization representing mutual funds and other investment products, says that 90% of all mutual funds have total fees of less than 1.72% and the median fee is 0.73%. Although some consumer advocates would dispute that claim, the only fees that matter are fees charged on the funds that the employee has access to, and if those fees are backed up by subpar performance, the employee may pay a lot to get nothing.

Employees need help and if they have allocated their 401(k) dollars on their own as well as chosen their level of contribution, it is likely that they will join the baby boomers, who are now retiring without enough money. The best way to get help is to self-direct some of the funds. If that isn't an option, find a fee-only financial planner. (For related readings, check out Reasons To Boost Your 401(k) Contributions.)

Related Articles
  1. Retirement

    It’s Never Too Late to Contribute to Your 401(k)

    Find out why it is never the wrong time to start contributing to a 401(k), even in your late 30s, 40s or 50s; discover how to maximize your savings at any age.
  2. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  3. Taxes

    The Basics Of A 401(k) Retirement Plan

    This plan has become one of the most popular retirement options. Find out why.
  4. Retirement

    6 Problems With 401k Plans

    If you pay attention to the problems here, you will be able to avoid the negative effects and meet your retirement goals.
  5. Mutual Funds & ETFs

    Which Fund Share Class is Best for Retirement?

    Mutual funds are a popular investment for retirement. Here's how to choose the best share class when investing in them.
  6. Retirement

    6 Robo-Advisors That Require Little to Start

    There are many well-regarded robo-advisor options that come with minimum investment amounts. Here are snapshots of a handful of them.
  7. Retirement

    Smart Ways to Tap Your Retirement Portfolio

    A rundown of strategies, from what to liquidate first to how much to withdraw, along with their tax consquences.
  8. Your Clients

    How to Construct an Annual Review for Clients

    One of the best things that advisors can provide to clients is an annual review of their financial situation. Here are some guidelines.
  9. Retirement

    Is it Safe for Retirees to Invest in Technology?

    Tech stocks are volatile creatures, but there are ways even risk-adverse retirees can reap rewards from them. Here are some strategies.
  10. Retirement

    Roth IRAs Tutorial

    This comprehensive guide goes through what a Roth IRA is and how to set one up, contribute to it and withdraw from it.
RELATED FAQS
  1. Am I losing the right to collect spousal Social Security benefits before I collect ...

    The short answer is yes, if you haven't reached age 62 by December 31, 2015. The Bipartisan Budget Act of 2015 disrupted ... Read Full Answer >>
  2. What is the maximum I can receive from my Social Security retirement benefit?

    The maximum monthly Social Security benefit payment for a person retiring in 2016 at full retirement age is $2,639. However, ... Read Full Answer >>
  3. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
  4. Where else can I save for retirement after I max out my Roth IRA?

    With uncertainty about the sustainability of Social Security benefits for future retirees, a lot of responsibility for saving ... Read Full Answer >>
  5. Will quitting your job hurt your 401(k)?

    Quitting a job doesn't have to impact a 401(k) balance negatively. In fact, it may actually help in the long run. When leaving ... Read Full Answer >>
  6. How does my spousal Social Security benefit work?

    If you have never worked or paid Social Security taxes, you will not be eligible to receive Social Security retirement benefits ... Read Full Answer >>
Trading Center