One of the challenges of managing retirement accounts is that their special tax rules make them less flexible and harder to change than nonretirement accounts. Your plan at work is probably the least flexible of all, especially if it’s provided by just one investment house with a limited array of investment options. Because deposits into retirement accounts are capped each year, it’s doubly important to make sure the investments you’re using are reasonably priced and are good choices considering your asset allocation target. Often, you’ll need to make investment choices in the accounts you have the most control over—your personal IRAs and your nonretirement accounts—to make up for weaknesses in your work plan options.

For example, most 401(k) plans offer an S&P 500 index fund, which is most likely the lowest-cost investment option in the plan. You can use this fund in your company plan and then use your other investment accounts—where you have more options—to buy the other parts of your asset allocation, such as your small-cap funds, bonds, or international stock funds.

Using expensive investments is never a good idea, but it’s even worse in your retirement plans. If you’re spending your limited deposits on investment fees and paying expenses with assets that otherwise would be growing tax-deferred (or tax-free if in a Roth account), then you’re wasting a finite opportunity to strengthen your retirement security.

Here are some warning signs and tips on dealing with high fees:

Most employers work hard to ensure the plans they offer their employees are reasonably priced. After all, most executives and managers are participating in the plans themselves. If your plan is expensive, either because it’s small and only offers mutual funds with high sales loads or it’s invested in a high-expense annuity, you should look at using your other investments to counterbalance the cost.

The advantages of your plan at work are the deposit minimums that are higher than you can make to your IRA and the possible employer match. Even if your work plan is expensive, it’s probably still worth contributing enough to get the full match. If you are in the 33 or 35 percent federal income tax bracket or live in a state with a high income tax such as California, New York, or Washington, D.C., it may be worth it to deposit the maximum to your work plan even if the fees are higher than you’d like. If this is your case, work hard to compensate by minimizing expenses in your other accounts.

If you’re not in a high tax bracket and you can’t afford to put the maximum allowed into your employer plan, you should look at whether a less-expensive personal account is better for you. If the most you can invest is $5,000 or less, then investing enough at work to get the employer match and putting the rest into a Roth IRA or regular IRA with lower fees may work better for you.

Variable annuities are investment and insurance products that combine the characteristics of a mutual fund with a life insurance benefit. The life insurance characteristic of the annuity places it under a tax regulation that gives the account tax deferral just like an IRA. Unfortunately, if the annuity is owned within an IRA, you are paying extra for tax deferral of the annuity, which the IRA already provides—this is a clear waste of money.

The number of companies offering variable annuities exploded after the tax reform laws of 1986, when many more companies entered the market. Many of the annuities offered have very high mortality and investment expenses. If you find yourself locked into one of these contracts, there are a few tricks for getting your money out and into an IRA with more reasonable costs.

Annuities charge two types of fees: annual fees and sales charges. The annual fees are account fees and mortality charges (essentially a life insurance premium) that are calculated as a percentage of the value of the account. You won’t see these fees on your account statement, but they’re being collected nonetheless, and they hurt the performance of your investment. Check the prospectus to see how they work in your specific account.

Sales redemption charges are made on withdrawals and represent a percent of the amount withdrawn. Fortunately, the percent charged decreases over time and usually disappears altogether within eight or nine years. This information is in the prospectus, but it’s also helpful to confirm the withdrawal fee details with a quick call to customer service at the insurance company who manages your annuity. The time clock on declining sales charges applies separately to each deposit you made into the annuity and runs on a contract year (which starts from the time the contract was issued), not a calendar year. If you made only one deposit, then you can calculate your sales charge using the prospectus schedule and the contract date. If you made subsequent deposits, double-check your charge with the company before making the withdrawal—and being surprised by the fee.

To escape high-cost annuities, your goal is to do a direct transfer from your IRA that holds the annuity into an IRA with lower-cost investments. Be sure your transfers are direct transfers, not 60-day rollovers—you can make only one 60-day rollover per year.

Many large, publicly traded employers match their employees’ 401(k) plan contributions with employer stock. The hope behind this scheme is to motivate the employees with a more direct interest in the fortunes of the company. Unfortunately, it can sometimes result in having too much employer stock in your retirement plan. Some investment gurus say you should invest in what you know, and you probably know your employer’s company very well, but being heavily invested in the company where you’re also earning a paycheck is too risky for safe retirement investing. Because of this, most companies will let you sell company stock made as an employer match fairly soon after it’s deposited. Sell the stock, and reallocate it into your other plan investments when you can. Try to keep your total company stock allocation exposure in your portfolio to 5 percent or less.

What looks like employer stock in your account could be shares, or it might be a mutual fund type account invested in employer stock or investment units that change value based on the stock performance. If your employer stock is really straight stock shares or can be converted to shares, a little-known tax provision lets you transfer the stock out of your 401(k) when you retire and only pay tax immediately on the original cost of the stock (see Chapter 11). If you’re employer stock has grown in value over the years, this might be a good strategy.

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