By Steven Joshua Samuel, JD, MBA, AIF® (October 2010)
Recent changes in the law and U.S. Department of Labor (DOL) rules about 401k plans provide opportunities and more information for employees. Companies offering 401k plans will soon be required to provide more easy-to-understand information about 401k plan fees, investment choices, and investment expenses to their employees. Accountability of 401k Plan fiduciaries and investment advisers is being increased. New types of investments are being offered within 401k plans with the goal of making investment decisions easier.
Here are five facts you should know about these changes and other 401k matters. As with all other important investment decisions, review all options with your investment and tax advisers as they relate to your particular situation.
1. Transfer of 401k Funds to Roth 401k Now Available
Most people are familiar with Roth IRA accounts. While a Roth IRA does not provide a tax deduction for contributions, the gain in the account is not taxed and all withdrawals are tax free.
Until 2006, the advantages of a Roth were available only in an IRA account and not in a 410k plan. In 2006, employers were given the choice of adding a Roth 401k to traditional 401k plans. The Small Business Jobs Act of 2010 allows employees to move money from their 401k into a Roth 401k account, even if they are younger than 59 ½. Previously, IRS rules allowed only people who were over 59 ½, disabled, deceased or who changed employers to move money from a 401k to a Roth.
2. Plan Fiduciaries Now Must Disclose 401k Fees and Expenses
Until recently, employees were given very little information about 401k plan fees and investment expenses. On October 14, 2010, the DOL, which is responsible for regulating 401k plans, issued new disclosure rules.
DOL regulations now require that 401k plan fiduciaries (the people in the company who are responsible for decisions about the plan) provide employees with quarterly statements showing the amount and nature of fees and expenses deducted from the employee’s 401k account. Basic information (and access to more comprehensive information) about each investment offered by the plan and the cost of each must also be provided in a format that allows employees to compare the investments available under the plan.
3. Company Officials and 401k Plan Advisers Are More Accountable
In recent years the Courts and the DOL have placed more responsibility on company officers and 401k advisers for ensuring that employees who participate in 401k plans are treated fairly. Until recently, employees could take legal action only against the company sponsoring the plan if they believed that 401k fees were excessive or investment choices inadequate. A 2008 US Supreme Court case expanded the rights of employees by permitting an employee to sue not just his company, but also to sue plan fiduciaries personally.
Employers are generally accountable for providing employees with education about their 401k investment choices. Proposed DOL regulations would hold investment advisers delivering this information for a fee to a “fiduciary” standard, meaning they must avoid conflicts of interest and place the employees’ interests ahead of their own. Advisers who are paid by commission may be subject to a lower standard of responsibility.
4. Target Date Funds: A Cautionary Note
Several investment companies now offer a type of mutual fund, known as a Target Date or Life Cycle fund, in 401k plans. These funds automatically shift investment funds between stocks and bonds on some periodic basis, with the goal of managing risk, increasing return, and becoming more conservative as the target date for the goal nears. According to DOL, about 7% of all money in 401k plans in 2009 was in a Target Date or similar fund.
However, funds with the same target date for retirement, say the year 2030, may invest in very different ways. Some Target Date funds may target “to retirement” and reach their final conservative retirement allocation in 2030. Other 2030 Target Date funds may target “through retirement” and not reach their final conservative allocation until as long as 10 years or more after the target retirement date. The risk and performance of these two different 2030 Target Date retirement funds could be very different.
Before investing in a Target Date fund within your 401k, be sure to obtain information about where the fund invests your money, understand how the fund will change the allocation among investments as time passes, consider how the fund fits with your other investments, and review the fees charged.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Target Date funds. This and other important information is contained in each fund’s summary prospectus, which can be obtained from your financial professional and should be read carefully before investing.
5. 401k Loans and Withdrawals: Know the Rules
Hard times in investment markets and rising unemployment have forced many people to resort to loans or withdrawals from their 401k accounts. According to an Investment Company Institute report, 17.5% of defined contribution plan (e.g. 401k) participants had outstanding loans as of June 2010. For those who have no better alternative than a loan or withdrawal from a 401k, a review of some applicable rules is worthwhile:
If you leave or lose your job you must repay your loan in full or the loan will be treated as a taxable distribution. In addition, a 10% penalty will be imposed if you are under age 59 ½.
If you have no other source for money for a critical need, a loan is better than a withdrawal if you expect to be able to repay.
If you are still working and under age 59 ½, you will have to qualify for a hardship in order to obtain a withdrawal.
As with all other important investment decisions, consult with tax and investment professionals before taking action.
Steven Joshua Samuel, JD, MBA, AIF® is the founder of the Dedham law firm Samuel, Sayward & Baler LLC and the financial services firm Samuel Financial, Inc. located at 858 Washington Street, Suite 202 in Dedham (781) 461-6886. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser. For more information, visit www.samuelfinancial.com.