401k Secrets You Need to Know

Many people invest their money in 401(k) plans. In fact, these are one of the most popular and trusted ways of saving among American citizens. However, a lot of people are unaware of how, exactly, these plans work, and that’s not a good thing.  

It’s important to understand how these plans work, as well as to be aware of some of the lesser-known “secrets” about them.

The Separate Account Charge Secret

Did you know that you may be being charged a separate account charge for your 401(k)?

Typically, you have to pay this fee (which is often carefully hidden) if your plan is owned by a life insurance company. Even worse, this is no small amount. It’s often as much as 1.25%.

The charge can go by many names, including:

l  Group variable annuity

l  Mortality & expense charge

l  Variable account Charge

If you find you’re paying this fee and you don’t like it, talk with your financial adviser about switching to a 401(k) plan that doesn’t make you pay this unfair fee.

The Revenue Sharing Secret

Look out for revenue sharing happening on your account. This is when money is getting shared among your service providers.

Unfortunately, when revenue sharing starts happening, it often means that you will be steered toward risky, high-cost investments. It can also indicate that you’re likely to pay higher than average administration fees.

It can be hard to tell when revenue sharing is happening, so, if you have questions or concerns, have a trustworthy financial adviser, one not directly connected to your 401(K), to look over it for ou.

As you can see, 401(k) accounts can be tricky and sometimes even misleading. With the right financial help and guidance, however, you can discover their secrets and make your knowledge work for you.

How to set (and achieve) financial goals

Without money (Photo credit: Toban Black)

With all the demands on your money—the needs of your kids and those of your parents, not to mention your own ambitions—it often seems like there’s not enough cash to go around. The solution: Set priorities that are flexible, but not too flexible.

By George Mannes 

You know what your financial priorities are supposed to be: Max out retirement savings. Build a cash cushion for emergencies. Get rid of any credit-card debt. Save for your kids’ college education. Pay off the mortgage before you retire. Problem is, for most of us there doesn’t seem to be enough money to fully fund all those purposes and put dinner on the table. Complicating matters are the legitimate demands of everyday existence—your kid needs a computer, your parents need help with bills, your car needs tires—as well as your aspirations. In light of all the pressures on your money, it’s understandable that you can’t always follow the standard advice to the letter. Balancing reality against the conventional wisdom requires tough choices and compromises, as well as insight into the forces that deter you from hitting your marks. Follow the steps here to set high but achievable goals while giving yourself flexibility to handle the intrusions known as real life. 

Master the Musts
The starting point for addressing infinite desires with finite funds is knowing what advice you really can’t ignore. Although financial planners have exhaustive ideas for allocating your resources, they can chop down the list quite a bit in a tight spot. Marjorie Fox, a Reston, Va. financial adviser, tells her clients there are three non negotiables: Contribute enough to a 401(k) to get the employer match (typically a quick 50% to 100% return on your money, depending on your company’s plan), accelerate pay-down on credit-card debt so that high finance charges don’t drain your resources, and work on building adequate emergency savings. “Everything else,” Fox says, “becomes ‘Well, it depends.’ ” 

Sort Out the Rest
It’s no small task ordering the rest of life’s priorities. (The world’s great religions have spent thousands of years on the effort.) But start by writing down everything you want that requires money you don’t have—anything from retiring at 60 to taking a two-week European vacation. Next step: Pare down the list. Pittsburgh financial planner Kathryn Nusbaum advises pursuing no more than five financial goals at one time; as she says, “once you go beyond that, it’s too much to get your head around.” That means adding two or three goals to your nonnegotiables, depending on whether you have credit-card debt or adequate emergency savings. 

Put the Plan Into Action
Once you’ve trimmed your list, decide the amount you’ll stash each month. Jill Gianola, a financial planner in Columbus, Ohio, suggests structuring your savings plan in increments of three to five years. “It isn’t instant gratification, but it’s see-able,” she says. So instead of intimidating yourself with the big number you’ll need for retirement, you might aim to have added, say, $50,000 between now and 2015.

Put those savings on autopilot: Have the money automatically transferred each month from checking to dedicated accounts. That way, inertia works in your favor—you’ll have to take action to undo your plan. You might also link your ho-hum long-term goal (socking away extra money in an IRA, say) to a pulse-pounding short-term one (such as a ski vacation). Set a rule that for every dollar you put into the vacation, you have to put 50¢ into the IRA. Because more of your money is going to something immediate and fun, you’re making saving for retirement more pleasurable, says Carnegie Mellon economics and psychology professor George Loewenstein. 

Prepare for Interruptions
No matter how well laid your plans are, you can be sure that life will intervene. You may have imagined a world in which once your kids graduated from college, you’d be off the hook financially. And until the day arises when your folks need help, you probably won’t have listed “providing parental aid” as one of your long-term goals. That’s not to say that it’s always other people who screw up the priorities: Sometimes your own circumstances or desires change.

So what’s the solution when something arises that calls your priorities into question? Well, it’s not to drive a dangerous clunker or to cut off your relatives (for financial reasons, at least). It’s to remember that your plan, however firmly set, is also organic. Although you have up to three goals that are nonnegotiable, the others are meant to be flexible to the intrusions of real life.

Of course, you shouldn’t rush to amend your plan the second a new demand presents itself. Get some perspective first. Towson, Md. financial planner Phil Dyer finds it helpful to ask clients this question: Why is this goal important to you? Knowing the story you’re telling yourself about the goal—“and there’s always a story,” Dyer says—can shed some light on whether it’s truly worth pursuing. 

Attach $$$ to Diversions
The assessment doesn’t just end there, however. You’ll also want to figure out the true cost of changing your plans, and not just in current dollars and cents, but also in terms of what you’ll have to give up. Can you live with the tradeoffs?

Another way to assess the costs of a diversion is to look to the money you’re currently directing to your goals—starting with the lowest on your list and working your way up—to see how many of them would have to be scratched if you chose to do the new thing. Put a mental picture to whatever you’d have to give up. If you would have to put off buying a new car, imagine yourself driving your current one in 2015. This exercise will help you fairly compare the new—and very vivid—demand to the other things on your list, which may not be so clear to you. Attaching a picture to a goal “gives the money concreteness,” says University of Toronto marketing professor Dilip Soman, who has done research on this topic. 

Learn the Art of Compromise
Okay, but what if these exercises make you realize that you can’t afford to pay for a home health aide to take care of Dad without doing serious damage to your own retirement plans? Rather than letting guilt subsume you, think about whether you can “massage your goal, and fulfill your need in a more creative way,” Nusbaum suggests.

Is there another way to get to the same end result? If the goal is to get Dad the care he needs, you might look into whether he’s eligible for government programs that would defray the costs; you might ask siblings to share the burden with you; or you might help him arrange a reverse mortgage.

Alternately, is there another solution that won’t cost as much? Return to the story behind whatever it is you want to spend money on, and see if there’s a different way to satisfy your motivation. You may also find that a halfway measure will do. After all, real life and compromise go hand in hand. 

From the August 2010 issue of Money

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