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).)

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.)

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