It’s easy to set the 401(k) and forget it. After you select the initial amount to take out from your paycheck, it’s often best not to overreact to the ups and downs of the market.
But Alex Foster, a financial advisor in Atlanta, wanted to know about the fees a client of his was charged in the 401(k). When the two looked at the disclosure together, it was clear something was wrong.
The fee disclosure form had provided the “wrong fund for the wrong fee,” says Foster, who runs AF Capital Management. And it included “funds that were no longer part of the plan.”
The 401(k) fee issue landed in the national spotlight last month when employees sued Massachusetts Institute of Technology, New York University and Yale University. The professors claimed that the universities did not do enough to prevent high fees in their 403(b) plans, which are non-profits’ version of a 401(k).
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The amount of fees in a 401(k) can have a drastic impact on lifetime savings. The National Association of Retirement Plan Participants says that over a lifetime median salary of $30,000, the difference in paying 0.25 percent in fees compared to 1.25 percent is more than $120,000. And that gap gets bigger, the more one makes.
NARPP also found that 58 percent of people participating in a 401(k) don’t know that fees are taken out. These folks don’t “understand the impact that (fees have) on their life savings,” says Laurie Rowley, president of NARPP, a nonprofit that advocates retirement plan improvements for employees.
In order to protect yourself from the impact these fees can have against your retirement, evaluate your own 401(k) by asking these three questions:
Are the right funds available to you? Investors should receive a disclosure that outlines the fund choices in a 401(k). This disclosure form is important because it highlights options the plan offers.
When Foster’s client received the form that outlined the different fund choices, none of them included an index fund. Instead, portfolio managers actively managed all the options, and many had fees near 3 percent. Foster advised his client to ask for some low-cost index funds, since the managed funds were so expensive.
“If they’re not using index funds, the managed funds could just be robbery,” he says.
Companies are now required to provide some low-cost options to their 401(k) offerings and, considering the lawsuits filed against universities and other companies, most businesses will add index funds quickly when asked.
But investors also have to understand how fees are charged. Rowley says that of those people that knew they were charged fees on their funds, only 25 percent knew how the fees were actually calculated. Many thought they “only get charged fees on the amount of growth on the account,” she says.
That’s not the case. The fee is on the entire amount placed within the specific fund. So if you have $100,000 in your 401(k), and 50 percent of that is in an index fund based on the U.S. stock market with a fee of 0.2 percent, then the fee would count against the $50,000 you have in the fund. That’s why you have to check all the funds your money is a part of, since one fund may charge 0.2 percent and another fund may charge 2 percent.
Foster tries to make sure his customers have a total fee exposure less than 1 percent, if possible, within the 401(k).
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Is the administrative fee in line with your company size? The fees for the fund aren’t the only ones within a 401(k). You’ll also have to check the administrative fee, which is paid to the company that manages the 401(k). This fee is sometimes difficult for people at home to easily find and calculate, since it’s just a line in a document, with a low percentage next to it.
And that’s one of the big problems with 401(k) fees, says Rowley. Since these fees typically range from 0.1 percent to 3 percent, people see them and think ‘that’s not very much’ because they compare them to the 10 percent or more charged in interest on a credit card statement or mortgage payment. But investors “can’t compare the two,” adds Rowley, since these fees accumulate over 30 years or more.
Brightscope found that smaller companies that have less assets within their 401(k) since they have fewer employees contributing, will have higher fees. The range for a plan that has $1 million in assets can be from nearly nothing to 4.5 percent. Larger companies, with plan assets over $10 million, typically have fees of less than 0.5 percent.
Should you take your money out of the 401(k)? When Foster’s client went to his bosses and asked for some index fund options, they quickly obliged. Foster thinks it only took two emails for everything to work out.
But that’s not always going to be the case, particularly if administrative fees are already set. That doesn’t mean an investor should exit the plan if a 401(k) charges fees greater than 2 percent. “The tax savings (of the retirement plan) trumps the high fees,” Foster says.
Investors don’t pay income tax on money that goes into their 401(k), because they can delay that payment until retirement and their income drops — putting them in a lower tax bracket. The difference between paying 28 percent on earned income now versus paying 2 percent fees and a reduced tax later makes staying in the 401(k) the best option, even without a company match.
[See: 15 Money Management Tips for College Students.]
Remember, though, if you don’t like the fees in your plan, “don’t be afraid to complain about the 401(k),” Foster says, because your company will typically force a change.
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3 Questions to Ask About 401(k) Fees originally appeared on usnews.com
