Written by Jeff Walker, Financial Planner

Retirement Account or Retirement Plan: What’s The Difference?

The most widely used and well-known retirement savings plan in the United States is a 401(k) plan. The term \”401(k)\” refers to Section 401(k) of the Internal Revenue Code. These types of plans allow employees to avoid taxation on their income if they elect to receive it as deferred compensation rather than a direct payment. Before 401(k)\’s retirements, most companies offered “Defined Benefit” plans otherwise known as pension plans, which offered employees a defined income or lump-sum payment upon retirement. Congress created 401(k) accounts in 1978 as a way to close a loophole on executive bonuses.

401(k) plans were never intended as a replacement for traditional (employer guaranteed) defined benefit pension plans — but today that is how they are often perceived. While there may be many benefits of 401(k) plans such as a menu of different investment choices and possible employer matching contributions, a 401(k) has many limitations as well.

1) Advice & Support: Pension plans were managed by actuaries and professionals well versed in creating a proper asset allocation and portfolio to withstand a variety of market conditions, but that burden & responsibility falls onto the investor in a 401(k). The average investor is unprepared and uneducated on portfolio design and most 401(k) plans do not have a designated fiduciary authorized to provide advice. According to research, the average investor returns a measly 4.25%. Investors\’ behavior or lack thereof and their emotional responses are the number one reason that people fail to manage their money properly.

2) Fees & Costs: No one works for free and 401(k)s are no different. Most plans have several fees and costs associated with them, but they are usually harder to find and less transparent. Fees vary greatly depending on the plan administrator, the plan’s features and benefits, the number of participants, and the investments themselves, but the average 401(k) fee according to research from TD Ameritrade, is 0.97%. Whenever a fee is assessed the question is always what value are you receiving in return?

3) Limited Menu & Target Date Funds: Many 401(k)s have a limited menu of investments and most utilize target-date funds or life cycle funds. Sometimes, these are the default option when people begin participating in these plans. Target date funds systematically shift their asset allocation over time from more aggressive stocks to more conservative bonds. The challenge with these funds is that they are a one-size-fits-all approach treating all investors the same despite their circumstances and preferences.

4) Planning: As people get closer to retirement or retire altogether, they usually look for more conservative strategies to protect their growth or look to create income. those strategies may not be the best moving forward.  Understanding that 401(k) plans were never designed to distribute money, protect it, or create an income stream – is the first step to understanding its limitations.

A 401(k) account is an important part of your retirement, usually, it’s the largest retirement account so it’s important to understand its purpose and how it can serve you best. Understanding that it is a 401(k) your money, but it’s not your plan, is the first step to creating more control and certainty in your retirement. If you have these plans, there are several questions you may want to consider.

1)Are you in the right investments? Feel free to contact us to help you review your investment options available in the plan and guide you in finding the right choices for you.

2) Do you have old 401(k)s, that should be consolidated? How do they fit into your retirement plan and are there better options available to you elsewhere?

3) Are you over the age of 59.5?  Does your plan allow for an “In-Service Rollover\”?  This is a provision most plans provide that allow you to rollover some or all of your retirement funds to an IRA, even if you are are still working.

4) How much should you contribute? Sometimes people put too much money in the 401(k), not understanding that tax impact later on in life.

5) Does your plan allow Roth Contribution? Understanding the tax advantages of Roth’s may be critical down the road to create a more tax-efficient retirement.

A 401(k) plan is just a retirement savings account, and not a retirement plan.

A retirement plan starts with establishing clearly defined goals. It considers all available resources; income, expenses, accounts, assets, as well as liabilities and risks or challenges that may arise along the way. This process concludes with several long-term and short-term actionable steps to increase the probability of accomplishing your goals and most importantly create more freedom and security in retirement. Contact one of our professionals today to help you with your retirement plan!