How does one discriminate a great retirement plan from an average one? After diving into the details, there are 4 important factors--and likely many more worthwhile factors--that can differentiate the best from the rest.
Contribution Matching: from an employee’s point of view, employer matching is a huge component of evaluating a retirement plan. Imagine an employee earning $100,000 per year (it will make our math easier). Each percentage point of employer matching equates to an extra $1,000 of free money to the employee (assuming they maximize their employer match).
That is huge! An 8% match vs. a 3% match is like a $5000 raise. When compounded over time, it’s even more impactful.
Let’s work the math in a different way. Each percentage point of matching equates to at least a 5% return on investment for this employee. How? An extra $1,000 of free matching for someone contributing the full $19,500 401(k) limit equates to a 5.1% return on investment (ROI) ($1000 return / $19,500 invested). Wow! Thus, matching should be a huge part of a great retirement plan, and the more matching the better.
Fees: whereas matching is free money and an increase to return on investment, fees are a detriment to ROI. And in today’s investing environment, which is heavy on passive investing, many great retirement plans boast low fees.
Investors know the difference and seek out low fees whenever they can. With financial education becoming more widespread, employee investors are more aware than ever of how important fees are. Compounded over 25 years, even a small 0.1% difference can decrease final portfolio size by 2-3%.
The lower the fees, the greater the plan.
Investment Options: the last 5-10 years have seen a bevy of investing companies and easy-to-use iPhone investing apps that are promising to “democratize investing.” Even average investors now expect to see a diverse set of investment options laid out before them, whether in their taxable brokerage account or in a tax-advantaged retirement plan.
While too many options can be an issue in and of itself—see: The Paradox of Choice—there is no doubt that having too few choices is not representative of a great retirement plan.
Resources: great retirement plans have a great set of resources for plan participants to utilize. What kind of resources? Well, let’s look at some of the common problems that future retirees face.
Determining time horizons. When can the investor safely retire? What assumptions go into that calculation? How could that answer change over time? An educated financial planning resource can help employees answer these questions.
Estimating expenses and tax planning. What do taxes look like in retirement, and how much “extra” money needs to be in a retirement nest egg in order to cover taxes in retirement? Again, this is a topic where an experienced tax-planning financial advisor can help retirement plan participants.
Risk assessment and glide paths. How should an investor’s risk tolerance change over time? And how will they adjust their investment allocations to “glide” into retirement? This is a (potentially) million-dollar topic that a great retirement plan can help its participants with.
Estate planning. Death isn’t a fun topic, but it’s an important topic, nonetheless. Great retirement plans help their participants think about how their wealth can be passed down to their descendants.
These four attributes--matching, low fee, investment options, and intelligent resources--separate the great retirement plans from the merely okay.
Where does your retirement plan stand?