Small employer’s 401k plans maybe too expensive

    A small, new employer with mostly young moderate income employees may have very little in 401k assets. This means the 401k Custodian won’t be able to give a low cost 401k plan, so the costs could be higher percentage than plans offered at a giant employer. An article in SmartMoney “For 401k’s size matters” discussed this.

     A good 401k should have available Institutional class shares of mutual funds with an annual fee of roughly 0.40% to 0.50% for actively managed bond funds and half of that or even lower for passive stock index or bond index funds. The lack of long term capital gains tax treatment in a 401k plus high fees may mean some investors should avoid a 401k and simply hold growth stocks in a taxable account and try to avoid selling the shares or at least hold them long enough to get a long term capital gain.

   The solution is for the employer to find a Custodian that allows a “brokerage window” and “in-service withdrawals”. This will allow participants to use something other than the expensive choices offered by the Custodian.

  An in-service withdrawal means that one can roll their assets from the 401k to an IRA tax deferred while still working at the employer. A brokerage window means that one can invest in any publicly traded security even though the funds are inside of the 401k.

  It is important to remember that some 401k plan participants may be tempted to gamble recklessly with their assets so perhaps they would be better off with their assets trapped in a 401k using very bland generic mutual funds even if the fees were high. Assuming someone has the maturity, discipline and patience to invest in boring, conservative, high quality investments then they should seek a “brokerage window” and “in-service withdrawals” in a 401k. This might be a good feature to attract job seekers, since only 22% of employers have a 401k Brokerage window.

  In transferring funds from a 401k to an IRA ask the broker to do a Custodian-to-Custodian transfer. Don’t withdraw the funds yourself and then attemp to deposit them into an IRA.

   I wrote an article “Do brokerage windows allow an advisor?” and “Protect 401k’s from stock crash with investment grade bonds”.

   Investors should seek independent financial advice.