Maybe you think your 401k plan comes free of charge, but it doesn’t. The dirty little secret is that 401k’s are usually a cash cow – for the plan sponsor, the fund company, maybe even your employer – and your 401k account pays the price. Although the law changed in 2012 to force 401k administrators to disclose plan fees to participants, most investors are just as clueless as ever. What difference does it make if you can’t change your 401k plan, you ask? Actually, you can make some personal changes that can be very beneficial, as we’ll see.
Let’s begin with some background: When 401k plans were created in 1978, no one predicted they would become such a significant part of our financial security. Before then, retirements were funded chiefly through pension plans, Social Security, and old-fashioned savings accounts. As the economy changed and the government offered tax breaks to businesses and employees, the pension plan system was soon replaced by one in which the employee was responsible for retirement planning.
Today, about 53% of the money in the $4.7 trillion defined contribution (401k, 403b, 457 plans) industry is invested in mutual funds. Fund companies such as Fidelity, PIMCO, and American Funds make a massive amount of money as 401k plan sponsors. While there is nothing wrong with profits, there is something fishy about the current system, where true costs are masked and salesmen use questionable tactics.
If you own shares in a mutual fund, you have to do some homework to figure out the true costs – and most of us hate homework. Mutual fund companies exploit our ignorance. For example, here are some of the costs you may not realize you are paying:
- Plan administration fees: These make up the bulk of costs associated with 401k accounts and are deducted directly from your returns, paid directly from the plan or paid by the employer. It’s close to impossible to find these fees when they are deducted from your returns, but the effect is to lower your growth (or increase your losses).
- Investment fees: These make up the bulk of the costs you will pay. You won’t find them anywhere on your statement but you can calculate them from information in the fund prospectus or the annual report (that thick booklet you probably toss out each year). These fees include –
- Loads: a commission of up to 7% that is applied to each fund purchase and sale. Load costs are sometimes charged by raising the share price to include the commission at purchase so that it appears you are merely paying the market price.
- 12b-1 fees: You pay these charges for the mutual fund to market themselves to you. This may include incentive payments to your employer to carry one company’s funds exclusively, regardless of whether the company is well managed or keeps costs low.
- Investment management fees: These fees for help with your account are assessed as a percentage of your account balance. Your returns will be shown net of these fees – hidden in plain sight.
- Individual service fees: Service fees are charged for features such as plan loans, account setup, and investment advice. Some of these fees must be disclosed, but others can be deducted from your account without notice. It’s important to ask before you sign up for a new feature if there will be a charge and how much it will cost you.
What are some steps you can take to help your retirement balance?
- BrightScope is the leading provider of 401k and 403b plan ratings. Compare your plan to industry metrics and if yours is poorly rated, lobby management for a change. They may be completely unaware.
- Read the Summary Plan Description (“SPD”) for your 401k. Surprisingly, very few employees bother to review this important document. It will give you information about your plan, such as whether it allows in-service distributions (rollout to an IRA while you’re employed).
- Get a professional review of your portfolio. An advisor that charges by the hour will take a look at your choices, make a recommendation, and help you rebalance annually.
- Choose passively-managed rather than actively-managed funds.
- Keep only enough stock in your employer to get the match or purchase discount. Think about it – if your employer’s business goes south, you could be out of a job and have a worthless 401k to boot.
- When you retire, don’t leave your money behind in your 401k. Rolling out to an IRA expands your choices to the universe of funds instead the limited few in your 401k
- If you absolutely are stuck with poor choices in your 401k, put in only enough to get the match and then invest as much as you can on your own. Start with a Roth IRA and then fund after-tax accounts.
Remember that all services have costs – just make sure you’re not paying thoroughbred fees for a jackass plan.