Would You Give Up Control of Your 401k for Much Higher Contributions?

Here's an interesting piece from Yahoo that details how one company (Devon Energy) is offering a "super 401k" -- but it comes with strings. The choice is to stay with the traditional 401k and make your own investment decisions or to get a much higher level of contributions and let the company manage the money for you. The main details:

Rather than rely on employees to take the initiative to save, Devon plans to save for them--by making annual contributions to these accounts in line with what it would have spent to provide a traditional pension benefit. Depending on an employee's tenure, the company will put 8% to 16% of annual compensation into the 401(k)--regardless of whether the employee kicks in a dime. For those who put money into the plan, the company will also match it dollar for dollar up to 6% of salary.

Add it all up, and Devon workers who divert 6% of their pay into the super 401(k) could receive as much as 22% per year from the company. While many companies that freeze pensions increase their 401(k) contributions, Devon "is one of the few coming close" to what's required to compensate employees for the loss of a pension, said EBRI's VanDerhei.

In return for its largesse, Devon plans to impose an unusual degree of control over how its contributions are invested. Under the new plan, employees are required to use "target date" funds. Already available in many 401(k)s, the funds recently got a big boost when the U.S. Labor Dept. approved their use as a default investment for accounts established under automatic enrollment programs. Designed to provide workers with all they need within one portfolio, the funds put investing on autopilot: Employees simply select the fund that most closely matches their expected retirement date and the funds' managers do the rest of the work, by shifting into a more conservative mix of stocks, bonds, and other asset classes as retirement approaches. Devon's target-date funds will consist of low-cost investments in its $614million defined-benefit pension plan, including alternative investments such as real estate investment trusts and inflation-indexed securities.

The article goes on to detail the issues Devon employees are considering. It seems like a no-brainer to me (take the money and run!), but it's a bit more complicated than that.

What would you do? Would you rather take 14% to 22% of your salary in a super 401k managed by your employer or take 6% and control everything yourself?

Comments

[Rick]

This is an easy answer. Use the target dates and take the 16-22%. Most 401ks don't allow you to invest in individual stocks so it is harder to beat the overall market. You can't pick apple or google, you will most likely have to pick a technology mutual fund or even a less specific growth fund. Lets use some numbers:

annual salary: $100
annual contribution: $6

My control (using my 401ks returns this year: about 8%):
$12 (my cont + their match) contribution becomes $12.96 ($12 * 1.08)

Their control (using the ytd of VTIVX: 10.61%):
$12 (my cont + their match) +
$8 (low end of their contribution) becomes ~$22 (20 * 1.1)

IF YOU PUT IN THE MINIMUM
Their control at the average market return of 8%.
($12 + $8) * 108% = $21.06

to match that number with your control you would need a return of
$12 * x% = $21.06
x% = 21.06/12
x% = 175.5% or a 75% return.

This 75% return is only need if you only put in the 6% to get their full match.

IF YOU PUT IN 20%
Their control at the average market return of 8%.
($26 + $8) * 108% = $36.72

to match that number with your control you would need a return of
$26 * x% = $36.72
x% = 36.72/26
x% = 141.2% or a 41% return.

Even if you put in 100% of your salary, you would need to average 16% return to match the company managed plan at 8% return. The less you put in, the more you need to return. Unless your 401k offers extremely specific options where you can take advantage of trends and specific outperformance, stick with the extra free money and the lower annual return. The disparity becomes even more pronounced one you hit the 16% of "free money". At 16% free and 20% of your contribution, you need to return 75% in your managed account.

[Edmund]

The fact that you can't buy individual stocks probably means you get higher returns in the long run ;)

[Patrick]

I would vote to take the higher 401(k) and be ecstatic! Very few people get 20% of their pay going directly into retirement funds and that would just be too much for me to pass up. I would continue to max out my Roth IRA as well. Wow.

[JC]

I'd keep control. I wouldn't trust "The Man" to take care of me.

[Robert]

It doesn't sound like the company is taking control of your finances, only that they have a limited set of choices, much like your average ordinary 401(K). Seems like a winner. Either this is a super company to work for, or they getting this while losing something else like the mentioned pension plan.

[Southsidetoby]

Wow, the answer here is easy: take the deal and derive the benefit from the higher contribution rates. I wouldn't be concerned at all about mismanagement, provided the company was complying with legally mandated disclosures to plan participants and I could monitor my account's activity online.

[Melissa]

I would take the extra contribution in a heartbeat. That sounds like a very good deal.