The market collapse of 2008 showed investors the hard way that 401(k) plans can lose money. What many still don’t realize is that even when the markets boom, 401(k)’s lose – typically from 0.5 percent to 2 percent of their holdings each year. That money goes to an assortment of fees that are usually buried in the plan’s quarterly statements, often within statistics like “investment gain/loss.”
But 401(k) participants should soon be receiving that information regularly from their companies, in plain language, with comparisons to other investments, thanks to a regulation the U.S. Labor Department expects to issue as early as June. The House in late May passed a tax-and-jobs bill with similar requirements.
Such moves could ultimately cut fees by as much as 25 percent by spurring competition, predicts Michael Fisher, president of Sequoia Financial Advisors in Phoenix and a member of the retirement-issues committee of the Financial Planning Association (a Denver-based trade organization for planners). “Because people don’t know what they’re paying now, it’s very hard to compete on an apples-to-apples basis,” he says. For its part, the Labor Department expects fees to drop $700 million per year, as plan officials bargain harder and switch to less-expensive types of investment options.
Any savings would help. With Social Security’s long-term solvency in doubt and traditional pensions disappearing, Americans will increasingly rely on 401(k)’s when — or if — they retire.
Where the Fees Hide
There are three basic types of 401(k) charges:
• Plan administration fees, covering the bureaucratic costs of operating a 401(k), such as regulatory filings, accounting, and record keeping. While companies used to swallow this as a cost of business, 59 percent now take it out of employees’ plan savings — which is legal. It’s almost impossible to estimate the fees because there are so many variables, including the size of the plan, the types of services offered, and whether fees are charged as a set cost per person or as percent of assets.
• Money management fees (also known as the expense ratio in mutual funds), to pay the firms that handle the actual investment decisions. This is by far the biggest charge, typically ranging from 0.2 percent for basic index funds, to more than 2 percent for specialties like emerging markets funds that require intensive research. It includes various sub-costs, such as the 12b-1 fees that cover marketing and brokers’ commissions. For investments with extra risk protection, like insurance wraps, tack on an extra 0.2 percent to 1 percent; if the plan uses institutional funds rather than mutual funds, subtract 0.2 percent to 0.5 percent.
• Fees for special services, such as investment advice and loans. These are paid only by people using the services and typically cost $10 to $200 each.To get this kind of information now, investors have to dig into their mutual fund’s prospectus or website, look up fund-tracking sites like Morningstar, and ask their employer. But with the new regulations, their employer would actually have to hand out the information when an employee signs up, then once a year after that. Among other specifics, companies would have to reveal exactly how the administration charges “will be allocated to their individual accounts.”
The Power of Sunshine
Once participants know how much in plan administration fees they are paying, experts believe there will be incentives for companies to move to lower-cost plan options such as institutional funds. But with the new rules, it will also be easier for individuals to cut fees themselves, simply by avoiding high-cost funds and services.
And if they don’t like any of the choices in their plan, they could ask their company for more. Will the company listen? “Some will,” suggests Michael Goodman, president of the New York City-based financial planning firm Wealthstream Advisors and an official of the New York State Society of Certified Public Accountants: “The HR official says, ‘I’m paying these same fees. I want to negotiate a better rate for all of us.’ ”
Important as these costs are, however, they are not the only factors to consider. Just as critical – if not more so – are the investment’s risk level and historical returns compared with similar investments. Other considerations: The fund should have been in existence for at least five years, with the same management, and a consistent investment style.
Your bottom line
Ultimately, it comes down to how much you are paying. Says Fisher of the Financial Planning Association, “If you’ve got a mutual fund that’s performing very well and it’s charging you 0.05 percent more than the next fund, you’re not going to care.” Fortunately, with the new rules, it will be easier to know whether your hidden 401(k) costs are minimal, or a major drag on your returns.
Related Links:
Are fees draining your 401(k) retirement savings? – USA Today
http://www.usatoday.com/money/perfi/retirement/2009-08-24-401k-retirement-savings-fees_N.htm
Regulation Forthcoming On 401(k) Investment Advice – The Wall Street Journal http://online.wsj.com/article/SB10001424052748704879704575236300345263106.html
Does More Transparency in 401(k) Fees Matter? – SmartMoney
http://www.smartmoney.com/investing/stocks/does-more-transparency-in-401k-fees-matter/
What Your 401(k) Really Costs You – U.S. News & World Report
http://www.usnews.com/money/retirement/articles/2010/05/27/what-your-401k-really-costs-you.html
