I recently sat down with Chris Whitlow, the CEO of Edukate to talk about the 401(k). As many of you know, employers are knee-deep in annual reenrollments. This includes getting people to think about their investments, says Whitlow.
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According to Whitlow, many 401(k) holders do not really interact with their benefit. He explains, “The majority of people use 401(k)s as a ‘set it and forget it’ type of investment until they have to make some new decision.” Whitlow pointed out that that was very different than other benefits, like health care, where you must make elections every year—this serves as a reminder to interact with benefits.
I asked Whitlow why HR professionals care if their workers are making the most of their 401(k). Whitlow said that “HR folks do inherently want to see the good of human capital and help individuals with the programs they implement.” He continued “since the 401k is the status quo, it’s the primary driver, financially, to get employees engaged.”
Why Don’t People Participate in or Engage their 401(k)s?
I asked Whitlow what made it so challenging for employees to participate in or engage in 401(k)s in the first place. He began by explaining that because people only stay with companies an average of 4 to 5 years, they have more immediate needs than a 401(k) in the form of more short-term benefits.
Another factor involves a simpler concept: “parting with your paycheck,” says Whitlow. He continued to explain that you can’t pull your funds out (without penalty) until your late fifties, and many have more immediate financial concerns. It can be a real challenge for people to save for the future when they need to spend in the now.
A major reason why many don’t really engage with their 401(k) opportunities involves the traditions of investing, says Whitlow. He explains, “investing traditionally has been for the wealthy, and the 401(k) plan is the primary driver of investment assets for most Americans, especially those that make the median income or below.” What this means is that many are asked to invest for the first time when it comes to a 401(k), and they won’t have the benefit of knowing the language and concepts surrounding investment. Whitlow says, “that can be intimidating for a lot of folks. The industry has tried to build investments and build tools around assisting in that but clearly, we still have a long way to go to educate people throughout the entire process, so they feel more comfortable and confident.”
Hidden Benefits
We all know that 401(k)s are for retirement, but I asked Whitlow what else they could do. “It’s a tax-qualified investment,” says Whitlow. In other words, the IRS says that funds inside a 401(k) are a qualified account. Whitlow explains that traditional 401(k) account gains are not taxed until you take them out, meaning your investments accrue tax-free. He also explained that Roth 401(k)s tax the money as it goes in, but then accrued investments are not taxed, even when you take them out. This is unlike many other kinds of investments, and the bottom line is it means more money stays with the holder in the end.
Whitlow listed a few other benefits:
- Assets in qualified accounts like 401(k)s cannot be touched should you ever file for bankruptcy, unlike many other assets.
- 401(k) matching programs from employers essentially give you free money whenever you contribute. Things are a little more complicated than that when you start talking about vestment and maximum matching percentages, but any amount of free money is a good thing. When was the last time your bank did that with your checking account?
- Finally, 401(k) plans through employers come with requirements that fiduciary responsibilities are met. That means that employers need to guarantee fair fees that investments are reviewed with due diligence. When you invest on your own, these perks are by no means guaranteed.
- You can pull some of the money out without penalties for going to school, accessing loans in certain cases, and putting money toward a first-time home purchase. The interest that is charged is paid back to you instead of to a bank with other types of accounts.
Of course, these benefits do come at a little bit of a cost. “If you have immediate financial needs,” says Whitlow, you cannot use these funds without major penalties to address them.
Why Reallocate Your 401(k) Every Year?
As we discussed above, most 401(k) holders set and forget their investments. However, that is potentially unfortunate for the success of their 401(k). Whitlow explains, “some of your investments will grow and some of them will fade over time because the values of those investments change.” So, you might have selected a great batch of investments for 2017. But by 2018, maybe some are stronger, but another few might not be making much money at all. If you adjust your funds regularly, you can keep the good and get rid of the bad.
Chris Whitlow is the Founder & CEO at Edukate.