Written by Phil DeAngelo, Focused Wealth Management
401(k) retirement plan fees may appear negligible at a few pennies on the dollar. However they add up to a colossal amount of money for your nest egg over the span of your entire career. The vast majority of the 53 million people who take part in an work-sponsored 401(k) plan in the U.S. don’t know how much they’re paying in annual expenses and that they could be paying a lot less. If they do know about the high fees, it’s tough to complain for fear of offending the one who signs the paychecks.
Participants typically pay a management fee of 0.67% of assets annually for 401(k) retirement plans, according to research conducted by the Investment Company Institute and Deloitte Consulting. Fees tend to decline the larger the plan. Group retirement plans with $1 million to $10 million in assets under management pay an annual expense ratio of 1.27% on average. Plans with $10 million to $100 million in assets under management, 0.82%; $100 million to $500 million, 0.57%; and $500 million and up, 0.37%. Smaller plans end up paying higher rates owing to the fixed costs of administering the plan, the report found. Employees typically pay 87% of 401(k) costs.
I recommend using the free calculator at 401kfee.com to figure how fees will affect your nest egg in the long run. Let’s say you start with $10,000 in a 401(k) plan, contribute $10,000 each year and make an average investment return of 7% each year over two decades. The calculator reveals you would save $769 a year in a plan that charges an expense ratio of 0.67% annually versus a plan that charges 1.27%. After 20 years, your plan would total $415,304 if you paid the 0.67% yearly management fee versus $387,832 if you paid 1.27%. That’s a $27,472 difference. After 30 years, the difference mounts to $93,890 and after 40 years, an eye-popping $259,213.
Plan fees mostly come from the management fees of the mutual funds offered in the program. Actively-managed funds are more expensive than index funds. Actively-managed mutual funds carry an average annual expense ratio of 0.92% versus only 0.13% for index funds, according to ICI. The tinier the 401(k) plan, the less likely it offers index funds. Ninety-seven percent of plans with $1 billion and more in assets under management offer at least one index fund. Whereas only 79% of those with $1 million to $10 million and about two-thirds of plans with under $1 million have index funds.
Fees in 401(k) plans have declined 30 percent in the last decade as employers lobbied providers to provide index funds and lower-cost products, says Brian Reid, chief economist at the Investment Company Institute. As a result, money has been piling into passively-managed index stock funds in recent years at the expense of actively-managed stock funds. Last year, index stock funds had $166.6 billion in inflows, according to Nasdaq. By contrast actively-managed stock funds had $98.4 billion in outflows.
So if you’re paying sky-high 401(k) fees, what should you do? If your 401(k) plan has only high-cost mutual funds to chose from and no index funds, invest the minimum amount possible to take advantage of the maximum employer match. Put money away on your own in a traditional or Roth individual retirement account, IRA. Invest in low-fee index mutual funds or exchange-traded funds proving exposure to a U.S. index, a global index and a bond index.
Ask your employer to negotiate with the plan’s adviser to provide lower-cost funds or simply lower the fees themselves. A Wall Street Journal article featured a woman who was paying a 1.50% expense ratio for her 401(k) plan. She asked her employer to get the fee lowered. Her boss took up the issue with Wells Fargo Advisors, the plan’s adviser, and had the fee slashed in half to 0.75%.
Consider target-date ETFs or mutual funds. They aren’t offered in many 401(k) plans but over the past decade have swelled in popularity. Their assets under management eclipsed $500 billion as of 2013, according to Morningstar. Target-date funds are highly diversified, rebalance regularly and invest more conservatively as you approach retirement. They’re excellent for people who don’t have time to take care of a portfolio or have limited knowledge about investing.
The Obama administration recently announced an initiative that would require investment managers in charge of retirement savings accounts to have a “fiduciary duty.” They would have to invest in accordance with their clients’ best interests instead of investing in products that are just “suitable,” as the rules require presently. The president is trying to solve the problem of advisers investing clients’ retirement savings in vehicles that pay advisers high commissions but rachet up fees for clients.
For many years already, registered investment advisors (RIAs) have had a fiduciary duty to search for the lowest-cost plan on behalf of clients. Acting in clients’ best interests is their professional duty. Anyone in financial services responsible for retirement accounts should do the same regardless of any forthcoming laws.