Updated: 8/17/2012 7:28 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.
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While I believe the disclosures are a good thing, I just received mine, and it seems to be layed out and formatted to be deliberately confusing with crazy colors and buried headings. I'm a fairly intelligent person, but it took me quite a while before I understood it. I just wonder how many people will study it to that extent or simply give up and deem it a bunch of mumbo jumbo that doesn't affect them.
And about those buried fees... A few years back my employer brought in a rep from our 401K company to answer questions and encourage people to sign up or increase contributions. During the meeting, I pressed the guy to explain all the fees. He insisted that there were no fees. My obvious follow-up question was, "Then how does your company make money?" He had no good answer. He appeared to be a very good liar, and it later hit me that he probably believed what he was saying. I mean, he probably wasn't at a high enough level in his company to be privy to all their tricks. Without the new mandatory disclosures, how on earth would any of us ever find out the truth? And I guess part of me is still skeptical that the disclosures will include all the fees.
As long as greed exist in the world we will have people being ripped off!
All these 401K charges were approved by congress at some point.....lobbying money paying of.....
Same as LTD insurance (long term disability insurance)...if you ever get sick and need to claim LTD insurance, the insurance doctor has the last say and he doesn't EVEN HAVE TO SEE YOU....that one was signed by Reagan.....look at the fine print of your policy.
What can anyone really do if your 401K is ripping you off....stop saving .....Our government already knew it was ripping you of because they signed the bill.
i am a 401k consultant / advisor. the new DOL regulations regarding fee disclosure will do what the author says...give employers and participants better info about the fees they are paying. for an advisor like me, who charges at the lower end of the spectrum anyway, it's a tremendous opportunity for me to review plans, and show employers where they can get better service at a lower cost (a cost structure already built in to my business model). i take issue with some of the author's analogies at the very outset of the article (the car analogy is really off base), because the expense info has always been available, and readily provided to those that asked for it. the new regs require an even fuller disclosure, on a mandatory basis. if you've gotten yours already, it's probably 8-10 pages and it will glaze your eyes over.
for those on this string who cannot appreciate or do not understand how these plans really work, let me give you another way to look at this...
you come to work
you earn a paycheck
you put some back for retirement (i.e. PERSONAL RESPONSIBILITY)
your employer adds some to the account (their contribution, which is NOT MANDATORY)
let's say its a $1-$1 match like in safe harbor plans...you basically doubled your money, done so on a tax-deferred basis, without impact of investment returns. positive returns compound this upside, and it would take a 50% loss on new money EVERY YEAR for you to basically break even with your own money!!!! how is that a bad deal?
This is where Wall Street rips you off. The stock market isn't rigged (the bond market is another story). The Wall Street guys invest your money (so they don't even have to save their own) and can get a 1.5% or greater return (in some cases) for themselves all the while under performing the broad market. You can't even get a guaranteed one year return of 1.5% on your own money. There is no reason to pay someone that much to underperform. No one and I repeat no one is good enough to outperform the market while managing tens or hundreds of millions. The only reason they can get away with it is because your 401k likely puts you into these crapy funds and because so many consumers are don't know much about finance.
Plenty of funds to chose from, ALWAYS the lowest cost and many have stellar returns.
During the meltdown you heard and continue to hear many big, established mucky muck firms going under or investing badly or gorging themselves on bail out money, or being investigated for breach of fiduciary trust.
Did you hear the name Vanguard? No, no you didn't.
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