A recent headline in the Los Angeles Times managed to rile both supporters and detractors of the 401(k) plan industry’s opaque and often excessive fee structure. Citing new research, The Times asserted that “401(k) Fees Could Reduce Average Nest Egg by 30%.” There is definitely a problem. But that seems extreme.
If the finding were correct it would mean that $510,000 that a hypothetical dual-earner couple could have saved for retirement over 40 years with no fees would be reduced to $355,000—an appalling outcome. The author of the report, Demos, a research group, says this reflects all costs, including explicit charges and hidden expenses related to plan administration and stock trading.
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Yet even a frequent critic of 401(k) fees, Mike Alfred, CEO of retirement plan analyzer BrightScope, says in the story, “I’m not quite sure the problem is as large as stated.” Meanwhile, the American Society of Pension Professionals and Actuaries has blasted the report and the trade group Investment Company Institute insists the finding is in gross error. The ICI estimates that the average person pays $248 a year in 401(k) fees, which would cost the average dual-income household less than $20,000 over 40 years.
Let’s just assume reality is somewhere in the middle. That still leaves us with a problem. Many people assume that their employer pays all 401(k) costs, which is not the case. The Transamerica Center for Retirement Studies found in its 13th annual survey that 71% of employees with a 401(k) do not realize they involve fees.
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Even employers are often in the dark when it comes to understanding the fee structure of their 401(k) plan, the GAO has determined. It isn’t unusual to find 401(k) plans with total costs paid by the participant exceeding 3% annually—double what a well-run plan should cost — which is one reason that new fee disclosure rules are on the way. Here’s what you can do to minimize hidden fees in the meantime:
- Stick with index funds Part of the cost of investing in a 401(k) is the same cost you bear with any mutual fund: the expenses that the fund manager incurs running the fund. These may be 1.5% or more on actively managed funds. Index funds cost a fraction of that—less than 0.2% in some cases. And studies have shown that 401(k) investors who stick with index funds for the long haul, and do not try to time the market, enjoy higher than average returns.
- Consider an IRA You’ll enjoy greater investment choice and generally lower costs in an IRA. Consider rolling your 401(k) assets into an IRA if you switch employers, or opening an IRA instead of contributing to a 401(k). But if your 401(k) plan offers matching contributions it’s probably your best choice.
- Beware of insurance products Fees are especially difficult to understand with insurance-based products like variable annuities, which may charge 401(k) participants 2% annually.
- Don’t borrow It’s a bad idea to borrow from your 401(k) anyway, unless you have no other options. If you do take a loan you may get hit with an individual service fee. This may be the case for taking advantage of other plan features as well.
- Talk to HR You may be stuck with the 401(k) your employer provides. But you can ask for change. Encourage HR to look into the plan’s fees and seek better options. Ask for more fee disclosure and for more investment options with lower costs.