April 10, 2018 by Main Street Coalition
Studies show that most Americans are concerned that their savings won’t be enough when it comes time for retirement. Simply encouraging Americans to invest more in 401(k)s, isn’t enough to address this issue. It’s important to foster an understanding of the retirement investing space so that Main Street investors can better evaluate their plans and options. We have outlined some basics terms of retirement investing:
- 401(k) Plan: a retirement investing option established by employers to which employees contribute a portion of their salary (thereby reducing it) on a pre- and/or post-tax basis. Employers may also elect to make contributions to the plan for their employees or add a profit sharing feature to a plan. Other important features to note include:
- Some plans allow employees to select their own investments from a core group of investment products that the plan has to offer
- Plan earnings accrue on a tax-deferred basis – this means that these earnings are not taxed at the time they are earned, but rather when they are withdrawn from the plan
- IRS regulations generally limit how much employees can contribute to their plans in a given year
- Withdrawing from a 401(k) plan has rules, including restrictions on how and when employees can withdraw their invested assets, which include the potential for penalties if withdrawals are made before the employee reaches retirement age as defined by the plan
- Fees: as of July 2012, 401(k) plan administrators are required to disclose the fees associated with the plan in a quarterly mailing to plan participants as fees can impact overall returns and thereby their financial security in retirement. Per the Labor Department’s 2012 rule, this statement must include the rate of return on investments, investment-related fees and expenses; the fees investors play fall into three basic categories:
- Investment fees: the largest piece of the fees investors pay; these fees cover plan management and are generally levied as a percentage of investment performance.
- Plan administration fees: fees to cover the basic administration of a plan – record keeping, accounting, legal services, etc.; these are sometimes charged directly, in which case they are charged based on the size of the account, and sometimes covered by investment fees deducted from investment returns
- Individual service fees: fees associated with optional plan features that can be added on to the overall administrative fees
- Expense ratio: indicates what it costs an investment company to operate a fund – calculated by dividing a fund’s operating expenses by its average assets under management. Operating expenses reduce the overall returns to investors, so the higher the expense ratio the lower the returns investors are likely to see.
- Risk Tolerance: the degree of variation in returns an investor is willing to weather. Factors that contribute to this include an investor’s time horizon, future earning potential, other asset holdings and more. It’s important for investors to have a realistic sense of their own risk tolerance, basically how much money they’re willing to lose for the chance at gains in order to make smart investment decisions.
Main Street investors need to understand these terms so they understand their disclosure forms and performance statements. Only through a regular reviews of the terms, fees and forms can American investors effectively advocate for themselves and, more importantly, ensure that their retirement investments are being properly managed.