In this article, we’re going to lay out important factors 401(k) planners should consider: 401(k)’s Flexibility and 401(k) Loans.
401(k) is steadily becoming one of the most important sources of income for retirees. In fact, according to Gallupp, 1 in 4 retirees use a retirement savings account such as a 401(k) as a major source of income. They also highlighted that half of non-retirees expect their 401(k) to be a major income source in retirement.
Since there are a lot of people depending on their retirement savings account, it’s best to know the dos and don’ts.
These considerations should help you understand the best practices for 401(k) planning!
First, let’s talk about flexibility:
In one of our previous articles, we discussed the importance of third party administrators and compared their performance to in-house personnel. What we’re going to discuss next is something similar. It’s about bundled vs unbundled providers of 401(k) plans.
Simply put, a bundled model serves as a one-stop shop while an unbundled model enables the plan to be more flexible and has specialized providers.
To help you choose which model fits your needs the most, we’ve compared a number of factors that are related to bundled and unbundled plans:
- Complexity – bundled plans have lower complexity because only one service provider is handling everything
- Investment selection – unbundled plans have wider investment selections because they let the best-in-class providers do their specialization
- Costs – bundled plans generally cost less
- Administrative burden for the plan sponsor – unbundled plans have slightly more burden
- Point of contact – bundled plans only have one point of contact while unbundled plans have multiple
- Need for legal assistance – both models have the same needs for legal assistance
- Education – bundled providers have typically limited education, similar to a “jack of all trades, master of none”, while unbundled providers have a more specialized education to meet the most optimal of investments
- Range of services – unbundled plans have a wider range of services because of the multiple independent providers
To summarize, when it comes to data reliability and quality of service, unbundled providers should be considered. While it may cost more, the expenses aren’t that much higher because unbundled providers work hard to provide comparable costs, especially if recordkeeping offers revenue sharing.
Many small businesses tend to choose a bundled plan because they have a lack of staff.
However, unbundled services are also attractive because small companies can grow while adding wider varieties of investment options.
Now, let’s talk about 401(k) loans:
There is little merit to taking a 401(k) loan, even if it’s your last resort. This is because the loan will make you pay interest (to yourself) in the long run. It’s undesirable to pay interest of any kind, even if it is to yourself.
Here are some factors to consider before you start taking out 401(k) loans:
Forced defaults from changing jobs – an outstanding 401(k) loan balance becomes due when you leave your current employer. In most situations, you will be unable to pay back your loan, so you will be forced to default. The defaulted balance then gets subjected to state and federal taxes. These defaulted balances or ‘leakages’ to your 401(k) plan will make things harder for you to build up your retirement savings.
Losing the company match – it’s fairly common that borrowers from their own 401(k) accounts end up stopping or lowering their contributions while paying back their loan. All this can result to the loss of matching contributions, when a participant’s contribution rate falls below the maximum matched percentage.
401(k) loan interest is not tax-deductible – first investigate of alternatives before a 401(k) loan, such as a home equity loan because of its tax-deductible interest.
Substantial opportunity costs – you can earn more through investment options in the plan instead of using a loan balance.
In other words, 401(k) loans are generally bad loans to make. Easy access to this often makes a participant’s bad financial situation worse.
It’s important that plan sponsors carefully consider limiting loan availability to hardship criteria, so as to increase the chances of an employee to achieve retirement readiness.
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