What you’re really paying in 401(k) and IRA fees
A recent study by the Federal Reserve, the Survey of Consumer Finances, found that Americans’ retirement savings in IRA and 401(k) plans are not quite as solid as they should be. If you’re going to be successful with your retirement savings, it is critical that you understand the fees and expenses you are incurring.
AARP did a survey on 401(k) participants’ awareness of the features of their plans, and the results showed that there are a lot of employees who really don’t understand how their plans work. It’s not a surprise, because the fee structures of these plans can be very complicated, and the fee disclosures are often written in complex language and are not always easy to uncover.
The AARP survey found that 65% of participants thought that they paid no fees at all, and only 17% stated that they do pay fees; 18% said that they just didn’t know. Another 83% didn’t know how much they pay in fees, and 54% responded that they did not understand the impact that fees can have on long-term investment performance.
401(k) plan fees and expenses can be separated into three categories. First, there are plan administration fees. Plan administration fees cover the day-to-day expenses of operating a qualified retirement plan, paying for items like record-keeping, accounting and legal services, trustee services and third party-administration..
Second are individual service fees which are participant-driven and cover things like self-directed account costs, loans, withdrawals and QDROs, which are qualified domestic relations orders. Individual service fees are typically charged to the participant.
Third are the investment fees. They are very important to understand and are usually the largest component of plan fees and expenses. You need to check to see what mutual fund share class is being used in your plan. Some plans offer institutional shares while others have retail shares. Retail shares have different types of loads. “A” shares charge a front-end load. “B” shares charge a back-end load. “C” shares have a higher ongoing trail fee, generally an additional 1%. Index funds are typically low-cost and should be an option available to plan participants.
Another type of common investment fee is the 12b-1 fee. 12b-1 fees are ongoing fees paid out of the fund’s net asset value on a daily basis. They can be used to pay commissions to brokers or other salespeople, to pay for advertising and other costs of promoting the fund and to pay other service providers in a bundled-services arrangement, including record keeping and third party administration. No-load funds can have 12b-1 fees. Most load funds have 12b-1 fees in addition to the load or commission. These fees are disclosed in the fund prospectus, but very few participants understand their significance. Some plans offer exchange-traded funds (ETFs) which have been slow to catch on, but can provide participants with a lower-cost fee structure than retail mutual funds.
The 401(k) plan has been around since 1978 when Congress made it possible with the Revenue Act. In 2012, the Department of Labor issued new regulations to make qualified plan fees more transparent.
The impact of fees cannot be understated. According to the DOL, “Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7% and fees and expenses reduce your average returns by 0.5%, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5%, however, your account balance will grow to only $163,000. The 1 % difference in fees and expenses would reduce your account balance at retirement by 28%.”
Understand the fees you pay and consider the services and investment performance you get in return. Don’t make investment decisions based on fees alone.
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Kenneth Roberts is an author, radio show host and private wealth manager with over 22 years of experience in the industry. More information can be found on his blog at sellacalloption.com.
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Graeme Cowan Sep 30, 2014
The greatest part of the fees are accounted for in the mutual fund returns that are reported. Yes it is typically 0.3-0.9% but it is excluded from the “advertised” return. If you the like the returns on the prospectus or via Morningstar or what is typically reported go for the fund. The fees charged are incorporated in the return. WHAT IS THE BIG DEAL.
H HSU Sep 29, 2014
Other revenue sharing fees were not discussed such as dealer concessions and administrative allowances on top of the management and 12b-1 fees.
On the quarterly participant statements, Department of Labor regulations require the plan administrator to provide an estimate of the fees each participant pays.
In a good plan practicing their fiduciary duty should benchmark their fees as way to show how they stand with plans of comparable size.