High fees can cost your 401(K)
A common misperception among retirement plan participants is that their 401(K) and other investments somehow grow over time without someone paying for it.
Too many participants merely look at the mix of their investments and the rate of return without giving a second thought to the costs associated with the plan, despite new rules approved by the U.S. Department of Labor in 2012 to help increase the transparency of these fees.
The rule requires retirement plan participants to receive an explanation of fees and expenses on general administrative services, including fees for legal, accounting and recordkeeping services. Fees actually charged to a participant's account must be reported quarterly.
Still, too many retirement plan sponsors and participants don’t focus on expenses. This common oversight can lead to a significant loss – possibly tens of thousands of dollars – in retirement savings.
Let’s say you are employed with a 401(k) balance of $25,000 and 35 years to go until retirement. If the return on your investments averaged 7 percent annually, and fees and expenses reduced the yield by 0.5 percent, your account balance would grow to $227,000 at retirement, according to figures by the U.S. Department of Labor.
However, if fees and expenses were 1.5 percent, your balance would grow to only $163,000 – a percentage point difference in fees and expenses would reduce your balance by 28 percent.
In this example, should you choose to make contributions over the next 35 years, the difference between the two account balances at retirement would be even greater.
Various factors impact a plan’s expenses, including the number of participants, total asset pool and type of investments.
Larger retirement plans typically have lower overall expenses - the fees deducted for management and administrative expenses, operating costs and mutual fund expenses - as they drive value through scale when compared to smaller plans. A Plan that holds mostly actively managed funds will be more expensive than one that uses index funds.
Generally, participants should be wary when the Plan fees approach two percent or more.
Industry averages for overall plan fees fall below two percent, even for a small plan of 10 participants with $500,000 in total assets, according to the 401(k) Averages Book.
There is another reason to pay close attention to plans with higher costs.
Plans with higher fees often have poor oversight that can result in reduced retirement outcomes for participants because fund options in these plans tend to have lower rates of return than 401(k) Plans with lower cost funds.
In fact, the expense ratio is a better indicator of return than past performance, the tenure of an investment manager or any other metric a plan advisor may use for evaluation. Experience has shown that a low-cost fund is more likely to have better performance over time.
The key for plan participants is to understand the disclosure forms that come in the mail when detailing the performance and expenses of their retirement savings plans.
Alesco Advisors can help compare the expenses of different plans. Often these disclosures will detail the fees for managing the plan, recordkeeping and more.
If you find your plan costs are too high, begin a constructive dialogue with your employer to determine how the issue may be best addressed.