Q. I have read about the Couch Potato index investing and about high fees in 401(k) s. I found out that my American fund fees start at 1.46 percent and go up to 2.08 percent. My employer does not match now and won’t in the future. My employer approved a regular IRA rollover to take the majority of my $200,000 plan balance and invest in the Vanguard index funds. I'm contributing 10 percent to my 401(k) at this time. My question: Because of the high fees and no match with my employer, should I stop contributing to my 401(k) and make contributions to my regular IRA at Vanguard? Or should I let the $200,000 sit in the regular IRA and open a Roth IRA? I'm 62. —T.W., by email
A. Funds in the American Funds group tend to have relatively low expense ratios. According to the Morningstar database, for instance, the average expense ratio for all of its funds is 1.03 percent. The expense ratio for its Capital Income Builder load-waived A shares— the shares often used in 401(k) plans— is 0.66 percent. That’s well under the 1.50 percent average expense ratio for world allocation funds as a group.
The high expense ratio you are paying suggests that your plan is using “B” shares, which have higher 12b-1 fees. Buy Capital Income Builder as “B” shares, for instance, and the expense ratio rises to 1.44 percent.
With such high expense ratios in your plan— and with no employer matching funds— you would be better off with an index fund company like Vanguard. Your 401(k) plan funds must earn about 1.25 percent more than an index just to stay even. And that doesn’t include the higher cost of transactions in managed funds.
There is, however, one wrinkle to opting out of the 401(k) plan in favor of an IRA— the contribution limits are different. You can contribute $16,500 to a 401(k) plan, plus another $5,500 in “catch-up” contributions if you are 50 or older. That’s a total of $22,000 a year.
The limit on IRA plans is only $5,000 plus another $1,000 in catch-up contributions, a possible total of $6,000. If you can save more than $6,000, you may need to save in both. To avoid unnecessary complexity, I suggest staying with the tax-deferred plans.
Q. I’m 61 and considering payment options on an employer-funded defined-benefit retirement plan. It has a current balance of $80,000. Since I’m married, the plan default payment option is a 50 percent joint and survivor annuity. The annuity would make monthly payments of about $450 until my death. Assuming my wife outlives me (she’s 56), the payments would then drop to about $225 a month for her lifetime.
An alternative is to take a one-time lump sum payment and roll it over to an IRA. The lump sum could then be invested in a low-cost bond fund. An example would be the Vanguard High Yield Corporate Fund, with an SEC yield of a little over 7 percent and an expense ratio of 0.32 percent.
The lump sum option makes more sense to me because no matter what happens to the financial markets, or how long we live, the IRA would usually generate more monthly income than the annuity. And at the end, our estates will still be left with some part of the lump sum instead of zero. Am I missing something? —M. F., by email from San Antonio, TX
A. If you had invested $100,000 in this fund at the beginning of 1995 and taken monthly withdrawals of $583 a month ($7,000 a year) for the next 15 years, you would still have $98,315 left at the end of 2009. Over this particular period, the fund provided a better return than 75 percent of all high-yield bond funds, a performance that can’t be counted on for the future
Basically you are choosing to take a calculated risk over a guaranteed sum for life. Taking that risk brings you two benefits: (1) access to your investment for the remainder of your lives and (2) the possibility of leaving any money that remains to your heirs.
Historically, this has been a reasonable— but not sure— bet.