Want to Retire Early? Three 401(k) Features That Can Help

When planning for retirement, 401(k) participants should set a savings goal and develop a strategy for reaching that goal. To reach their goal at the lowest out-of-pocket cost, I recommend participants follow a simple 4-step strategy – start early, contribute regularly, invest appropriately, and lower fees. However, to reach their goal as soon as possible, participants will need some help from their 401(k) plan.

Here are three 401(k) plan features that can help any saver – including you – retire years sooner.

Minimal 401(k) Administration Fees 

All 401(k) providers charge administration fees for delivering for plan services such as asset custody, participant recordkeeping, Third-Party Administration (TPA), and professional investment advice. These fees can be paid by the plan sponsor or deducted from plan assets. When 401(k) administration fees are deducted from plan assets, they reduce participant account returns dollar-for-dollar.

That’s not the worst part. Once fees are paid out, their amount can no longer earn compound interest. That means you won’t just miss out on their amount in retirement – you’ll also miss out on their future earnings. The following chart demonstrates how dramatically these losses can snowball over time assuming $20,000 in annual contributions and a 7% rate of return (compounded daily).

 

10 Years

20 Years

30 Years

40 Years

No Annual Fees

Account Balance

289,660.56

872,926.14

2,047,399.97

4,412,341.08

Loss due to fees

0.00

0.00

0.00

0.00

0.25% Annual Fee

Account Balance

285,655.90

846,658.50

1,948,417.35

4,112,173.01

Loss due to fees

(4,004.66)

(26,267.64)

(98,982.62)

(300,168.07)

0.50% Annual Fee

Account Balance

281,720.92

821,337.63

1,854,935.64

3,834,720.26

Loss due to fees

(7,939.64)

(51,588.51)

(192,464.33)

(577,620.82)

1% Annual Fee

Account Balance

274,054.69

773,390.28

1,683,194.18

3,340,883.23

Loss due to fees

(15,605.87)

(99,535.86)

(364,205.79)

(1,071,457.85)

2% Annual Fee

Account Balance

259,501.47

687,332.41

1,392,682.23

2,555,567.65

Loss due to fees

(30,159.09)

(185,593.73)

(654,717.74)

(1,856,773.43)

Keeping 401(k) administration fees to a minimum is incredibly important when saving for retirement. The reason is compound interest. It can grow even small fee savings over time.

Investments That Earn (At Least) Market Returns

With 5.5 million participants and $558 billion in assets, the Federal government’s Thrift Savings Plan (TSP) is the largest defined contribution retirement plan in the United States. Despite the TSP’s mammoth size, it does not use actively-managed funds – which try to outperform their market benchmark (e.g., the S&P 500 index). Instead, it uses passively-managed index funds – which try to match their market benchmark. That choice can seem surprising until you know that most actively-managed funds actually underperform “comparable” index funds (i.e., index funds with a similar benchmark.) 

Fees are often the reason. Active-managed funds can cost several times more than comparable index funds. The problem - few have a history of offsetting their higher cost with higher returns - especially over long periods of time

In short, it’s not easy to outperform top index funds from leading providers such as Vanguard, Fidelity, or Schwab. Avoiding actively-managed funds that deliver lower net-of-fee returns can help your account compound earnings faster.

Professional Investment Advice

To retire early, you must invest your 401(k) account appropriately throughout your career. This means constructing - and maintaining – an investment portfolio that balances growth potential and risk of losses. Striking this balance is important. Otherwise, you could miss out on gains by investing too conservatively when young or sustain unrecoverable losses by investing too aggressively when near retirement. That’s a tall order for most people when you consider the complex investing principles involved – asset allocation, diversification, and rebalancing.

If you don’t feel comfortable applying these principles, I strongly recommend you seek professional investment advice. Just about all 401(k) plans today offer one or more of the three basic forms - Target-Date Funds (TDFs), a financial advisor, or “robo” (algorithm-based) advice. To pick the best form for you, you should weigh their pros and cons.

A recent Aon Hewitt study found professional investment advice increased the median returns of 401(k) participants by 3.32% annually. These dramatically higher returns can help you retire years sooner.

Retire Years Sooner!

The priciest thing you’ll probably buy in your lifetime is retirement. Perhaps you’ve never thought of “buying” retirement, but that’s exactly what you do when you contribute to a 401(k) plan – you’re saving now to afford income in retirement. When you consider that income may need to last 10, 20, even 30 years, it’s easy to understand why retirement is not cheap.

However, three basic 401(k) plan features can help you reach your retirement saving goal years sooner.