Why Your 401(k) Is Broken (And How To Fix It)

401(k) is brokenMy 401(k) savings grew to a plump 6-figure level after 14 years of participating in my employer’s plan. For 13 of those years, it was a very crappy 401(k) plan due to poor fund selection, high expense ratios (fees), and third-party adviser fees.

The third party did nothing after 2004. But they still took fees every pay period for more than a decade.


After about six years of lobbying, my employer finally caved and switched to a more established provider with no third-party fees. The new plan is cheaper for the company and has a better variety of lower cost funds for employees. Still not awesome, but I was happy for a change.

Fees were costing me thousands in the original plan. I figured I could have left my job and saved $4,000-$5,000 a year in fees by moving my 401(k) to an IRA with a broader selection of investments.

Had the plan offered better funds from the beginning, I’d be wealthier today.

Why Your 401(k) Is Broken (and How to Fix It)

Your 401(k) situation may be broken for a number of reasons.

  • Your employer doesn’t have one
  • They have one but you aren’t participating
  • You aren’t contributing enough to get the match
  • The fund selection sucks
  • The fees are too damn high
  • You don’t know how to allocate your money

Your employer doesn’t have one

The Census Bureau estimates that 79 percent of U.S. workers have access to a 401(k) or other defined contribution plan, but only 41 percent of those eligible employees made contributions.

Your 401(k) may be broken and you don't even know it. Here are some common problems with 401(k) plans and how to fix them. Plus a free 401(k) analysis.You can lobby your employer to offer one to employees if they don’t have one. If that is fruitless, you’ll have to settle for contributing to a traditional IRA to get inferior tax savings. Another option is to find an employer with a plan.

By switching to an employer with a 401(k), you can contribute up to $18,000 (for 2017) and lower your tax bill. If there’s a match, it’s free extra money. Make sure to consider the 401(k) when you’re negotiating salary and benefits.

If you’re self-employed, you’re eligible for a solo 401(k) which is sweet. Read more about the solo 401(k) here.

They have one but you aren’t participating

Fix this ASAP.

You aren’t contributing enough to get the match

A big part of contributing up to the match comes down to understanding the plan verbiage. The wording can be confusing.

The plan will say something like the employer matches 50% of employer contributions of up to 8% of salary. That basically means it’s a four percent match, but you need to contribute eight percent of your salary to get it.

In this case, contribute a minimum of 8% to your 401(k). Always contribute at least the minimum. If you don’t, you’re turning away free money.

The fund selections suck

This one hurts because I dealt with it for 13 years. Signs of bad fund selection include:

  • Funds only available from a single managed mutual fund company (i.e. American Funds)
  • No index fund or ETF selections
  • High expense ratios on all funds (greater than 0.75%)
  • Third party adviser fees (12b-1 fees)

You want to see at least some index funds with low fees. If there’s a third party involved, like the sales guy my company trusted, fees are even greater. That’s a sales cost tacked on called a 12b-1 fee to account for “marketing and distribution costs”… better known as kick backs.

Ask your administrator if there are any 12b-1 fees. Ask the third party if they’re a fiduciary (meaning they are legally required to serve your best interests.).

If your 401(k) is showing any of these red flags, talk to your HR department and get answers. Tell them you don’t like your plan and explain why (bad funds, high fees). Then encourage your coworkers to do the same.

Took me six years to get results, but the management finally did change the plan. Unfortunately, their apprehension to change probably cost me tens of thousands of dollars.

The fees are too damn high

Every mutual fund and ETF has something called an expense ratio. That’s a euphemism for fees. It’s a percentage number that represents the net annual fees you’ll pay for the fund to be managed.

You can find the expense ratio anywhere you get mutual fund and ETF data. Ideally, it should be right on your 401(k) administrator’s website in addition to the prospectus. It’s available on the summary tab of Yahoo Finance or from your online broker.

A typical low-fee index fund should have an expense ratio of less than 0.25%. Many are under 0.10%. Managed mutual funds, which are funds with managers who pick stocks, tend to be closer to 1% or more. Managed international and emerging market funds tend to be even higher.

About 80% of managed mutual funds underperform the low-cost index fund benchmark. You can try to guess which 20% of the managed funds will do it year after year (hint, very few), or just go with the index funds. Fees vary drastically with the quality of plans and how well your company negotiates a deal. This is often based on how large your employer is because the bigger companies have more leverage.

You don’t know how to allocate your money

OK, so your employer has a plan and you’re contributing at least up to the match. Now, which funds should you put your money into?

If your money isn’t invested consistent with your risk tolerance, you may not be maximizing the potential of your account.

Not everybody understands how to allocate a 401(k) portfolio. What’s difficult here is that everyone’s age, goals, retirement timelines, income, and plans differ. You can’t just send me or your buddy an email to ask what funds are best. There’s a number of factors to consider.

Let’s dig a little deeper.

How to Allocate Your 401(k) Contributions

Let’s pretend on Monday you started a new job. During orientation, the HR dude went over benefits, tax forms, and ethics, and then briefly touches on the 401(k). He explains the rules and the match, but can’t offer any suggestions about how to allocate your 401(k) contributions.

You’re on your own.

So you’re hesitant to even start contributing at all. But you know from reading cool blogs online that you MUST begin contributing to your 401(k) because it will make you wealthy over the long-term. So how do you invest the money?

There are a few factors to consider. First is age. How old are you and when do you plan to retire? Then what’s your risk tolerance? And what funds are in your plan?

I’m 42 and plan to retire at age 55. But I can’t easily access my 401(k) money until I’m 59 1/2 unless I convert it to a Roth IRA. So my investment horizon is still about 17 years.

If you’re 24, it’s a solid 35 years before you can touch the money. If you’re 57, your needs are completely different.

All investors, regardless of age, should diversify their 401(k) funds. Don’t put all your eggs in one basket. Make sure to diversify your stock investments between large, mid, and small market capitalizations and both domestic and foreign stocks. Add more fixed income exposure as you age.

The basic idea for allocating funds in your 401(k) is the younger you are, the more heavily weighted to stocks you should be. The older and closer you are to needing the money, the more heavily you should be weighted toward lower risk investments such as bonds and money market funds.

Sounds simple, but limited fund choices or high fees can complicate things.

If you’re still not comfortable or confident in making the allocation decision, you have a few other resources.

Age-Based Target Funds

Most plans (except crap ones like my old plan) have some kind of age-based target fund. These funds are a set-it-and-forget-it way for new and inexperienced 401(k) to get started. The funds are managed to have different investments based on your age.

So there’s a pre-packaged diversified fund for 24-year-olds, 42-year-olds, and 57-year-olds, and everywhere in between.

They follow the basic allocation rules. Younger investors more stocks. Older investors fixed income and cash.

The age-based funds are modified to be lower risk and volatility as you age. That’s why you can set and forget them. Investing in one of these is better than putting your money into the money market fund.

The problem is they tend to be very conservative no matter what age you are. For example, an age-based fund for a 24-year-old may hold 80% stocks and 20% bonds, which is a bit too conservative.

Another drawback is the management fees. They tend to be at about the same level as a regular managed mutual funds and higher than index funds. If you don’t know what you’re doing, or fund selection is preventing you from getting started investing in your 401(k), an age-based portfolio may be right for you if available in your plan.

Age-based portfolios have come to popularity in the past decade. If your plan doesn’t have one, ask your HR department to get with the times.

A Human Adviser

Lastly, if you really are clueless or scared and don’t like the idea of a robo-adviser, it’s probably worth speaking to a fee-only adviser about allocating your 401(k) contributions. Especially if your balance is high.

Find a fee-only Certified Financial Planner (CFP) who accepts appointments on an hourly basis for an hourly fee. One hour should be enough time for an ethical CFP to help with fund selection. Make sure the adviser is a fiduciary. Keep in mind, they always want more of your business, so explain you only need help with your 401(k) if that’s all you want. Your allocations will need to change over the years.

I don’t normally recommend getting adviser help since most of this stuff isn’t too difficult and they’re expensive. But small tweaks to a large balance can make a huge impact over many years. You don’t want to F this up by keeping your money in cash or only bonds.

How is your 401(k)? Crappy like my old one? Or plenty of low-fee options? I’m curious to hear about the quality of your plans and who the good providers are (aside from Vanguard and Fidelity).

Photo credit via Pixabay

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  1. The company I was with for 20+ years used Fidelity, so no issues there. My son who’s 18 and working part-time just got access to a 401k at his company with T.Rowe Price. I’m just about to dig into it with him. Hopefully they have some good options.

    1. Fidelity is good as long as they offer some of their index funds, formerly known as Spartan funds. TROW has always been more of a managed fund company. Don’t know what their fees are like, although I own the stock for the dividend.

  2. Blastmaster says:

    I am fortunate that the bulk of my 401k is through the federal TSP. The fees make Vangaurd ETFs look expensive. After maxing out the TSP at 18k per year I am fully funding a Roth and a nonworking spouse Roth each year through Vangaurd VATSAX. Did finally roll the old job IRA through American Funds into Vanguard. Now if I can stick to the plan through a market crash, I should retire before my Dad also!

    1. Blastmaster,
      Kind of like that old video game, Blaster Master. Every play that on NES?

      TSP is decent, but not a lot of investment options. Low fees do help balance that out. Sounds like you’ve got your $hit together. Good luck!

  3. Good treatment of what to look at in retirement plans. It’s really a shame that we can’t get better oversight on the costs that are buried in plans. Someone who works 30 years and has a crappy plan can lose tens of thousands of dollars to unnecessarily high, and sometimes hidden, fees. Thanks for shedding some light on the dark corners of an overly secretive system.

  4. RBD,

    I also have some first hand experience with this one. My old employer had a 4% match (1 to 1), which I took advantage of, but the fund choices were just ok – not horrible, but not good. My new employer is 6% (also 1 to 1), plus they offer a Roth 401K. I am not maxing out yet, but I am socking way 9% of my annual plus the extra 6% on top of that. I now have 3 solid index funds / etfs, with fees at 0.01% or lower.

    Hope everything is good over there – including withe the new owner – and that our DC weather actually stays pretty nice like it is now.

    – Gremlin

    1. Gremlin,
      That’s some good matching you have there. I’m not a fan of the Roth 401k because I like the tax deduction of that 18,000. But to each his/her own. All’s good so far with the new ownership. Although they have a big challenge ahead of them merging the businesses.