Businesses should routinely evaluate 401(k) plans

Rick Imhoff is senior vice president of Sterling Trust.

The past three years have not been very kind to participants in 401(k) plans. Sadly, some participants just threw up their hands and stopped making contributions. The folly of their decision will show up when they decide to retire if they are able to.

This is not a good situation for the employer either, who will likely have to deal with lower morale and spend more time in education with their employees about the importance of participating in the plan.

In addition, it may be more difficult for the plan to pass certain tests forcing owners, key employees and highly compensated employees to reduce their contributions or the company having to make additional contributions on behalf of nonhighly compensated employees.

To improve the situation, employers need to take a hard look at their 401(k) plan and determine what should be changed or improved to increase participation.

Too many choices

One of the biggest issues with 401(k) plans is that participants have been overwhelmed by too many investment choices. Many participants do not have the expertise, or take the time, to research and understand their choices. Having to choose from 30 or more mutual funds can be a difficult task.

What is the appropriate number of choices? No one really knows for certain, but you can cover the bases with as few as six or seven mutual funds. In any case, certain criteria should be met by each fund for inclusion as an option, including low expenses, management tenure, investment style, investment performance relative to its peers and appropriate benchmark, and adherence to its stated investment objective.

Some plans offer asset allocation funds, fund of funds or life cycle funds to simplify the participant's decision-making process.

However, participants are still faced with the decision of putting all of their account balance in one of these types of funds or dividing it among other funds that concentrate in a single asset class.

Administrative costs

Many employers pass on a large portion of the administrative expenses of a 401(k) plan to the plan participants. This method of paying the costs of providing a 401(k) plan does not violate any laws, but it may make it more difficult for plan participants to have an opportunity to outperform the market.

One important rule of making investment decisions is to minimize expenses. By the time you add up the expenses to run the mutual funds, participant recordkeeping costs and other required fees to administer the plan, participants may end up paying as much as 23 percent of their account balance for these expenses before they make any money.

From the employer's perspective, does this really matter? In an investment environment like we had in the late 1990s, when 20 percent or 30 percent returns were common, these types of expenses could go unnoticed. But in today's investment environment where money market yields are less than 1 percent and bond yields are near historic lows, these expenses will definitely be noticed.

The bottom line with administrative expenses allocated to participants is that the participant may not be happy with the investment performance and his or her morale may be affected. Worse yet, if he or she decides to no longer participate in the plan, a great opportunity will be missed to build something for retirement.

Investment advice

The most unfortunate part is that many participants do not get the help or guidance they need to make good investment and asset allocation decisions. Many plan providers offer educational pieces or access to a Web site. However, many participants do not look over or clearly understand the educational pieces and many never access the Web site.

The best and most effective method for participants to get the investment guidance they need is to have a one-on-one meeting with a qualified professional who is experienced with investments and asset allocation. The participant may also receive the necessary encouragement to participate in the plan.

The employer has an obligation to periodically evaluate all aspects of the plan so that the company and the plan participants are getting the full benefit the plan offers. Special attention should be given to the number of investment choices offered, the total administrative costs to provide the plan and the level of investment guidance participants are receiving. This not only helps keep the plan running effficiently, it also has the potential to reduce the participant's frustration and increase participation in the plan.