8/20/2012 2:15 PM ET|
Is your 401k ripping you off?
Fees can take a big bite out of your nest egg. Learn how to pick the right investment vehicle and avoid excessive charges.
Imagine walking into your local car dealership and spotting a vehicle you'd like to buy. But there's no sticker price on the car, and the salesman insists he can't tell you what it might cost.
A lot of different expenses go into car production, he explains, making it impossible to come up with a price for an individual vehicle. He suggests you sign over your paycheck so the dealership can deduct an as-yet-undetermined amount for the monthly payment, insurance, commissions and various add-ons. Whatever's left over will be deposited in your checking account.
You would, of course, be insane to accept such a deal. Yet that's essentially what's been happening with your 401k for years.
The companies that administer 401ks have been so good about obscuring costs that 71% of workers polled for AARP believed that they didn't pay any fees for their plans. (Someday, investors may learn there's no such thing as a free lunch, but probably not in my lifetime.)
Often fees are deducted "off the top" -- they're quietly taken from your investment returns (or added to your losses). Some plans disclose annual expense ratios, which are the ongoing costs for managing a particular investment option. But other fees -- for administrative costs, sales commissions, advertising, trading and insurance expenses -- often aren't easy to find.
Why fees matter
Here's a hypothetical example of how higher fees can reduce a 401k balance over a working lifetime. The example assumes that the worker contributes $5,000 a year for 40 years and that the underlying investments return a 7% average annual return.
|Annual fee||Total nest egg|
What's worse, a lot of employers don't know how much their workers are paying. For example: Investment management fees make up the bulk of total 401k expenses, according to a study issued by the Government Accountability Office. Yet half of the employers the GAO surveyed either didn't know if they or their workers paid investment management fees, or they thought that such fees were waived.
That's a problem, because by federal law employers are supposed to pay attention to costs. Companies that sponsor 401k plans have a fiduciary duty under the Employee Retirement Income Security Act to make sure the plan's fees and expenses are reasonable.
It's a little hard to imagine employers fulfilling their legal obligation to you if they don't know what those fees and expenses are.
The GAO put some of the blame on the investment companies that administer 401ks, saying their disclosures "can be very complicated and difficult to understand, which could reduce their usefulness to plan sponsors."
Enter the U.S. Department of Labor, which finally decided enough is enough. The government is demanding that investment companies provide clearer breakdowns to employers, and that employers pass that information along to you.
The investment companies were required to make the disclosures to employers by July 1. By Aug. 30, you're supposed to have the information in your hot little hands. If your employer misses that deadline, you should at least get the cost figures when your third-quarter statement is mailed out after Sept. 30. You'll get yearly cost summaries after that.
In these summaries, you should see:
- What each investment option in your plan costs you (the "total annual operating expenses"), expressed as both a percentage and as a dollar amount for each $1,000 invested.
- A list of fees for administrative services that are charged to or deducted from individual accounts, such as fees for legal, accounting and recordkeeping services.
- An explanation of any fees and expenses that you may incur based on actions you take, such as fees for trading, plan loans, hardship withdrawals or processing divorce decrees to split assets.
- Performance data that can help you compare each investment option against an appropriate benchmark.
- These disclosures aren't personalized. You won't be told how much your individual account is actually being charged, for example. But for the first time you'll have a big-picture view of your plan's costs.
But how will you know if the fees you're being charged are reasonable or outrageous? It's actually your employer's job to figure that out (remember that fiduciary duty stuff?). The Department of Labor is hoping all this disclosure prompts more employers to shop more carefully for their 401k plans; more comparison shopping should -- in theory -- result in lower costs.
But your employer may need a little push, especially if you work for a small company. Plans with less than $1 million tended to have the highest fees, according to a study by Deloitte and the Investment Company Institute.
If you work for a large employer -- as most 401k contributors do -- you probably have a pretty good plan. Participants in big plans often have access to lower-cost options than are available to investors outside the plans, said David Wray, the president of the Plan Sponsor Council of America.
Large companies have the people and the financial clout to negotiate a better deal, said Bill Harris, the CEO of Personal Capital, an online financial adviser that plans to launch a low-cost 401k plan for small and mid-size businesses.
"At smaller companies, the owners . . . are busy with other things," Harris said. "The owner might say, 'I need a 401k. OK, let's talk to my insurance guy.' "
Insurers are often more willing than big mutual fund companies to take on small accounts. Unfortunately, insurers typically offer more expensive investment options. Participants in small plans also can wind up paying proportionately more for various account services, since the costs are spread over fewer people.
One way to see if your plan's fees are reasonable is to look up your company on BrightScope, a financial information company that offers retirement plan ratings. (The site may not have a rating for small plans, however, because of lack of data.) If you register, you also can get a free "personal fee report" that summarizes what you're paying for your investments.
Then take a close look at your 401k disclosure forms. If you're seeing total annual costs for an investment option that exceed 1%, you should do a little digging. You can use a site such as Morningstar to check the expense ratios of comparable funds. (Vanguard typically offers low-cost versions of various mutual funds.) If your plan's option is significantly more expensive, or if the total expenses on any option top 2%, it's time to act. You can:
- Put your own money in cheaper options, for now. The Department of Labor warns that "cheaper isn't always better" -- perhaps not always, but often it is. There's no evidence that paying more for an investment guarantees better returns; in fact, the opposite is usually true. Low-cost index funds, exchange-traded funds or target-date funds may be your best choices.
- Let your employer know you care about costs. Recruit your co-workers, if you can, to request lower-cost options. You also might volunteer to serve on any committee that evaluates plan providers or investment options.
- Suggest automatic enrollment. Automatic enrollment significantly boosts participation in 401k plans, since people have to make the effort to opt out, rather than to sign up. Higher participation means more money in the plan, which means more clout in negotiating with providers. Automatic enrollment isn't always a slam dunk -- it may be too expensive for companies with a generous match or impractical for companies with high turnover. Often, though, tapping people's basic inertia can benefit both them and the plan.
- Enlist the top dogs. High earners -- top executives at bigger companies, the owner at smaller ones -- may have contributed more than average workers to the 401k plan. If so, they have more money at stake, and should care even more than the average worker about what happens to it. Send them a link to this article, or print it out and leave it on their desks.
- Invest on your own. If your plan continues to reek, you may need to take more of your retirement into your own hands by investing outside the 401k. If your company offers a match, you should contribute enough to the 401k to get the full amount. But you also can contribute up to $5,000 a year to an IRA or a Roth IRA ($6,000 if you're 50 and over). Set up one of these accounts at a low-cost provider, and you'll have a world of investments from which to choose.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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