Critical Advice From the ‘Father of the 401(k)’

Feb 04, 2022

Last week’s market update prompted some important feedback from Money Talks reader Dave T.

Because I suspect many other folks may be grappling with similar issues, I’ve decided to share it here today:

Keith,

Thanks for your continuing stream of beneficial insights into the market. I really appreciate it!

[I] haven’t been sure of how to handle my 401k, since we don’t have a lot of flexibility as far as investment options, and there is a two-trade limit per quarter in my company’s plan. I feel claustrophobic sometimes.

Is there any way to share any general tips, or guidelines, on how to handle a 401k in light of the market’s changing condition? I know that the simple answer is “move [your money] out of [stock] funds and park it in a money market account if you’re concerned.” But I don’t know if there’s a more intelligent way of protecting 401k funds.

Thanks for your consideration. Thanks for all your great emails, with so much beneficial content. Much appreciated!

Dave T.
Thank you for the kind words, Dave! I’m so happy to hear you’ve benefited from these emails.

And thank you for the question. As I mentioned, I suspect you’re not alone.

Longtime readers know I’ve been critical of traditional 401(k) plans — and mutual funds in general — in the past.

The reality is that most plans seem designed to benefit their administrators far more than the employees who invest in them. And unfortunately, in many cases, there isn’t a whole lot participants can do to get around this.

That said, I also understand that many folks have a big chunk of their retirement savings in 401(k)s. So, over the next couple of weeks, I’d like to share some ideas to help you protect your hard-earned money in these plans.

This week, we’ll start with a few simple steps you can take with just about any 401(k) plan to reduce your risk and improve your returns in any market environment.

These are ideas most people have heard at one time or another but often don’t follow. And it makes little sense to worry about the details if you aren’t taking care of the basics.

Next week, I’ll share some additional ideas you can consider to help optimize your performance in difficult market environments.

Sound good?

OK, let’s get to it…

In my opinion, any discussion of good 401(k) basics should start with a man named Ted Benna.

If you’re like most folks, you’ve probably never heard of him. But to those in the know, he’s considered the “father of the 401(k).”

You see, while the 401(k) is named after a special section of Congress’ Revenue Act of 1978, the law didn’t officially enact the retirement plan.

It wasn’t until Benna — a benefits consultant — realized that the new law would inadvertently allow employees to save pre-tax income and receive matching contributions from their employers that the 401(k) was actually born.

As you might guess, Benna is one of the foremost experts on 401(k)s today. But you may be surprised to learn that he is also among their biggest critics.

Why?

Well, like me, he believes they’re typically set up to benefit plan administrators rather than the folks who invest in them.

And a huge reason for that is fees.

Benna notes that in the early days, fees were relatively low and were generally covered by employers. Today, fees are significantly higher and are borne entirely by employees themselves.

As I’ve explained before, even small increases in fees can compound into huge amounts of money over the course of an investment lifetime.

This means today’s average 401(k) investor can spend hundreds of thousands of dollars — even millions of dollars — in additional (and unnecessary) fees.

That is money that could make a real difference in a person’s quality of life in retirement — and instead, it’s going into plan administrators’ pockets.

Benna also believes most plans are unnecessarily complex and offer too many investment choices. (I agree, though I might argue that most plans offer too many poor investment choices, and too few good ones. More on this next time.)

Finally, he believes most plans aren’t properly structured to incentivize long-term investing.

For example, it’s widely known that folks save more when their employers automatically enroll employees in a retirement plan. Yet very few plans offer this.

He also believes plans make it too easy to cash out funds when changing jobs or to borrow against your savings when money is tight. He says the latter is an especially bad decision, as you’ll then be paying the loan back with post-tax income, resulting in double taxation.

And he thinks it’s a mistake for most folks to take a lump-sum distribution at retirement, as this can increase the risk of running out of money too soon.

So what is Benna’s advice for the average 401(k) investor?

First, and most importantly, he recommends sticking to low-cost index funds OR a single low-cost target-date fund if available. (I say “if available” because many target-date funds have excessive fees, in my experience.)

As I mentioned earlier, just this one, simple step could give you hundreds of thousands of extra dollars for retirement.

So please, if you take only one piece of advice from this series, make it this one.

Next, Benna recommends maximizing your contributions to receive your employer’s full match.

This is just common sense. All things equal, if your employer is offering free money, you should take it.

If you can’t afford to maximize your contribution today, Benna recommends starting with whatever you can afford today and systematically increasing it over time as you’re able to earn or save more.

Finally, Benna urges you to avoid thinking “short term” with your retirement funds.

If you change jobs, you should roll your 401(k) over to a plan with your new employer or to an individual retirement account (IRA), rather than cashing it out.

Don’t borrow or take an early withdrawal from your 401(k) for anything less than a “life or death” emergency. (Or better yet, build up a rainy-day fund so you’re covered in emergencies, too.)

And if you’re near retirement, resist the urge to take a lump-sum distribution. Instead, Benna suggests withdrawing no more than 10% up front and annuitizing the remainder over time.

Again, this isn’t revolutionary advice. And much of it should sound familiar to regular Money Talks readers.

But I would wager there are probably more than a few readers who are overlooking one or more of these basics today. If you’re among them, I hope you’ll take a little time this weekend to reconsider.

As I mentioned earlier, it makes little sense to optimize if you aren’t already taking care of the basics.

That said, following this advice won’t address all the limitations of many 401(k) plans, including those Dave T. cited earlier.

So next week, I’ll be back to share some additional ideas to better protect your retirement savings during times of market turbulence.

In the meantime, I’d love to hear your thoughts on 401(k)s and what we covered today. As always, you can reach me at [email protected]. Please note that I can’t respond to every email, but I read them all personally.