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Is staying in an employer’s tax-advantaged retirement plan better that rolling retirement savings into a rollover IRA?

Here are the minimum requirements for a good quality employer sponsored retirement plan worth staying in. First, all investment and administrative costs should be fully disclosed and rock bottom in your employer’s tax-advantaged retirement account.  Second, an employee must have the choice of at least one very low cost, broadly diversified, low turnover, passively managed index mutual fund in every major asset category. At least then, he or she can compose a basic index oriented portfolio that would deliver the market return at minimal cost.

Employer 403b, 457, and 401k retirement plan and deferred compensation plan retirement accounts should have lowest cost index funds in all asset classes

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Employees in 403b, 457, and 40lk retirement plans and self-employed 401k retirement plans need access to low cost investment funds in a variety of major asset classes so that they can implement a personally risk-adjusted investment asset allocation strategy. The very minimum set of asset classes for these index funds would be the US total stock market, the total international stock market, investment grade domestic government and corporate bonds, and a money market fund with very low costs. It would be even better, if there were a much broader offering of low cost index funds, including perhaps international bond funds.

Driving the financial industry’s excessive costs out of the equation is the single most effective strategy that individuals have to keep the highest net return for their investment risk exposure. Too many employer sponsored retirement plans are littered with high cost, actively managed investment funds, which will tend to do worse than low cost index funds the longer they are owned.

The excessive costs of actively managed funds drag down net returns, and the financial damage is huge and cumulative. A passive index investor in a retirement plan is more likely to have a higher account balance at retirement after decades of savings and investing through very low cost investment funds.

Employer 40lk retirement plans and deferred compensation plans should not build up a concentration of company stock

Furthermore, you can get an indication of 40lk retirement plan and deferred compensation plan quality depending upon how company stock is involved in any company retirement plan. If the employer allows employees to purchase company stock within their retirement plan and particularly if there are no significant restrictions on how much company stock an employee can accumulate in their company retirement plan, this is a big red flag.

Across all of their investment assets (retirement accounts and otherwise) people should be very broadly diversified, and they should avoid all concentrated investment positions. If an employee holds more than 10% of their assets in their employers stock, that is a red flag. If an employee holds more than 5% of their assets in their employers stock, that is a yellow flag.

The problem with investment concentration is that people can lose their jobs and their income, if something happens to the business or even industry of their employer. If they also hold company stock in their retirement plan account, then they could be exposed to the awful double whammy of losing both their income and some or most of their retirement assets.

Investment concentration is highly undesirable, and should be avoided. If an employer encourages excessive accumulations of company stock by employees in retirement plans, then there are good reasons to question whether this plan is being managed in the best fiduciary interest of the employees.

Finally, if an employer sponsored 403b, 457, or 40lk retirement plan, self employed 40lk retirement plan, or deferred compensation plan does not offer one or more rock bottom cost, broad market bond index fund, then that can be a real problem. Higher bond fund investment management fees are completely and provably counter to employees’ best interests. Long-term historical broad market bond returns have averaged roughly a compounded 2.6% annually in real dollar, constant purchasing power terms with inflation extracted.

If a bond fund charges about 1% in management fees, which is about the average across bond mutual funds, then that means that these useless management fees are eating up more than one-third of an investor’s gross real dollar bond returns year after year. There is zero justification for high bond fund fees, unless you work for the financial industry. High fees are certainly not in the best interests of employees, if they are not given a choice to avoid more expensive bond funds in retirement plans.

Understand how 401k, 403b, and 457 retirement plan and deferred compensation plan retirement assets affect your taxes overall

The failure to offer low cost bond index funds in an employer sponsored retirement plan can also prevent an employee from implementing a cost-effective asset tax location optimization strategy across all of that employee’s taxable and tax-advantaged investment accounts. Asset tax location is the optimization of the entire portfolio with respect to taxes. Bonds and cash tend to generate more current taxable income that will be taxed at ordinary income tax rates. Therefore, it is more optimal to hold bond investments and non-emergency cash in tax-advantaged retirement plan accounts.

Stock assets on the other hand may experience capital gains as a much greater portion of total return. Capital gains are only paid when there is a sale of the asset or dividends are paid. If held for a year or more, then these capital gains are taxed at lower federal long-term capital gains tax rates, as are qualified dividends.

Stock assets tend to be more optimally held in taxable accounts from a total portfolio tax optimization standpoint. Therefore, regarding employer sponsored retirement plans, it is important that they have a full lineup of index mutual funds, but it is even more important that employees have the choice of a variety of very low cost bond index funds.

Is staying in an employer’s tax-advantaged retirement plan better that rolling retirement savings into a rollover IRA?

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