If it weren't for our 401(k)s many of us would be up the retirement creek without a paddle. This year, there are some noteworthy changes to 401ks. Here's what you need to know to take advantage of them.
For one thing, there are higher contribution limits for 2012. You can sock away $17,000, up from $16,500 in 2011, in your 401(k), 403(b) and the federal government's Thrift Savings Plan. However, catch-up contribution limits for those 50 and over stand still at $5,500.
Every dollar you contribute to your 401(k) or other employer-sponsored plan is tax-deductible. The more you contribute, the smaller your tax bill.
Another change that's all the chatter, is the rules requiring increased transparency around fees. "Better fee and conflict of interest disclosure will finally put buried costs and hidden relationships on the table for all to see and compare," says Jeff Acheson, a partner with Schneider Downs Wealth Management Advisors. "Daylight will be a great antiseptic and help prevent egregious fees and self-serving relationships from inhibiting the realization of satisfactory compound rates of returns within participants' account."
In the era of double digit returns, fees that were higher than industry standards were not a focal point as they were considered non-consequential and offset by high rates of return, he argues. But now, facing a period of time where investors' account performance may very well be measured by single digit results, the difference in fees may well make all the difference between achieving satisfactory outcomes or retiring with inadequate resources. "High fees that are undetected within complicated legal documents and products are a bit like undiagnosed high blood pressure, initially you don't necessarily see or feel, but the affliction over time if left untreated, it will kill you," says Acheson.
The hope is that transparency will lead to more competitive pricing, improved investment selection and lower fees, points out Mitchell Kauffman, a certified financial planner with Kauffman Wealth Services. Fees are huge in the retirement savings equation. While contributions to your account and the earnings on your investments will increase your retirement income, fees and expenses paid by your plan may substantially reduce the growth in your account. The following example from the U.S. Department of Labor demonstrates how fees and expenses can impact your account. Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.
There are a lot of unknowns regarding the new disclosure rules, but what is clear is that service providers for plans will now be more exposed than ever in terms of what they are charging. The results of this 'exposure' are yet to be seen, says Holly Danzinger, a pension consultant with Karel-Gordon & Associates.
However, plan participants will not see a full comparison of plan and investment fees until November.
Remember too, that while fees are important, there are other considerations. "The fee should not be your biggest concern. The returns should be. A poorly performing return with a low fee, is worse than a higher fee on a screaming return," says Grant Cardone, author of The 10X Rule: The Only Difference Between Success and Failure.
There is also a proposal that would allow workers to convert a portion of their 401(k) savings into an annuity, and also allows for the creation of a "longevity annuity" for retirement savings. With a "longevity annuity," also know as "deferred fixed annuity," retirees can take part of a lump sum distribution at age 65 and defer it for 20 years. That could save them an enormous amount of money, says Ty J. Young, president of financial advisory firm Ty J. Young. Converting a portion of a 401(k) to an annuity, could go a long way in dealing with the very real prospect of outliving your money.
So what can you do now? Employers will still have control over these decisions, but you can make your voice heard about fees and ask more questions. You can also do a little homework on your own. Brightscope is an independent provider of retirement plan ratings and analysis, you can get a report now to see how your plan stacks up. Take advantage of any financial education offered by your employer or push them to provide such services. Mostly though, max out your investment, especially if you're over 50.
There's much change on the horizon. Be ready to capitalize on them.