Saving for retirement? Watch 401(k) fees

July 21, 2010

The following is by John Wasik, a columnist for and author of “The Audacity of Help: Obama’s Economic Plan and the Remaking of America.” The opinions expressed are his own.

I’m not one to get excited over new government regulations, but you need to pay attention to some new rules just issued on 401(k)-type plans by the U.S. Department of Labor.

I bet you don’t know that more than a half-dozen fees can eat away at your retirement funds. The rules will tell you how much your retirement plan is costing you. Not only will you be able to tell how much your kitty is being diminished every year, you’ll be able to lobby your employer to cut expenses.

downloadThis is empowering for the more than 50 million defined contribution plans like 401(k)s and 403(b)s which have about $7 trillion invested. Since most employers pass these fees along to you—and they are deducted from your account—you may not realize how consistently your wealth is being depleted. It’s cruel and silent, although you can do something about it.

Seemingly trivial expenses add up to devour your retirement account. Say you have a $500,000 401(k) balance and are saving over 30 years at a modest 5 percent. At 1.5 percent in annual expenses, you will have paid more than $400,000 in fees and lost $386,000 in earnings.  Knock those expenses down to 0.5 percent and you’d save $485,000 over three decades.

Run some numbers yourself and see how much you can save. You won’t even have to do the math. Use the SEC’s free mutual fund cost calculator, a reliable tool for any kind of mutual fund (I used it to crunch the figures above.)

Employers have an obligation to provide a prudent plan. Since they are legally responsible for providing the best retirement plan at the lowest cost, those who may have been gouging their employees have been sued. In recent years, 30 large companies have been sued over alleged high 401(k) expenses.

Depending on the size of the plan, expenses vary widely. In general, the bigger the plan, the lower the costs: those with more than $500 million in assets generally pay the least expenses, according to a survey conducted last year by Deloitte Consulting and the Investment Company Institute.

The biggest plans charged from 0.14 percent annually compared to 2.2 percent for the smallest. For funds with assets between $10 million and $100 million, the median expense ratio was 0.78 percent and 0.41 percent for those greater than $500 million.

How much can you save? The lower the expenses, the more money you can put to work for your retirement.  In the meantime, start asking questions.

  • Look at expense ratios on the mutual funds within your plan. Ask to cut middlemen expenses and benchmark your plan relative to the best plans available for similar programs.
  • Look at record keeping, custodial/trustee, audit, legal and transaction expenses. Ask your employer to dump any mutual funds with 12(b)1 fees—which cover marketing expenses, commissions or revenue sharing.
  • Get rid of plans set up with expensive brokerage or insurance products. Insurers add another layer of fees for mortality and commissions.
  • Most large mutual fund and exchange-traded fund (ETF) companies can provide lower-cost administration and management. Actively managed funds have the highest expenses, which include trading costs for stocks and bonds.
  • Demand that your employer stock your plan with passive, low-cost index funds, preferably with institutional expense ratios of 0.20 percent annually or lower.

While the new rules are “interim”—the final rule won’t be published until a year from now—you can comment on what you’d like to see by August 30 by emailing the DOL directly. For now, you can benchmark your own plan by using Brightscope, which will suggest how you can lower costs even more.

You won’t be shaking the tree by requesting changes. Your employer will have a legal and economic incentive to pare the cost of your plan since their money is in it, too.


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