High Fees Eroding Many 401(k) Retirement Accounts
April 13, 2014
AP - And now a new study finds that the typical 401(k) fees — adding up to
a modest-sounding 1 percent a year — would erase $70,000 from an
average worker's account over a four-decade career compared with
lower-cost options. To compensate for the higher fees, someone would
have to work an extra three years before retiring.
The study comes from the Center for American Progress, a liberal
think tank. Its analysis, backed by industry and government data,
suggests that U.S. workers, already struggling to save enough for
retirement, are being further held back by fund costs.
"The corrosive effect of high fees in many of these retirement
accounts forces many Americans to work years longer than necessary or
than planned," the report, being released Friday, concludes.
Most savers have only a vague idea how much they're paying in 401(k)
fees or what alternatives exist, though the information is provided in
often dense and complex fund statements. High fees seldom lead to high
returns. And critics say they hurt ordinary investors — much more so
than, say, Wall Street's high-speed trading systems, which benefit pros
and have increasingly drawn the eye of regulators.
Consider what would happen to a 25-year-old worker, earning the U.S.
median income of $30,500, who puts 5 percent of his or her pay in a
401(k) account and whose employer chips in another 5 percent:
— If the plan charged 0.25 percent in annual fees, a widely available
low-cost option, and the investment return averaged 6.8 percent a year,
the account would equal $476,745 when the worker turned 67 (the age he
or she could retire with full Social Security benefits).
— If the plan charged the typical 1 percent, the account would reach only $405,454 — a $71,000 shortfall.
— If the plan charged 1.3 percent — common for 401 (k) plans at small
companies — the account would reach $380,649, a $96,000 shortfall. The
worker would have to work four more years to make up the gap.
(The
analysis assumes the worker's pay rises 3.6 percent a year.)
The higher fees often accompany funds that try to beat market indexes
by actively buying and selling securities. Index funds, which track
benchmarks such as the Standard & Poor's 500, don't require active
management and typically charge lower fees.
With stocks having hit record highs before being clobbered in recent
days, many investors have been on edge over the market's ups and downs.
But experts say timing the market is nearly impossible. By contrast,
investors can increase their returns by limiting their funds' fees.
Most stock funds will match the performance of the entire market over
time, so those with the lowest management costs will generate better
returns, said Russel Kinnel, director of research for Morningstar.
"Fees are a crucial determinant of how well you do," Kinnel said.
The difference in costs can be dramatic.
Each fund discloses its "expense ratio." This is the cost of
operating the fund as a percentage of its assets. It includes things
like record-keeping and legal expenses.
For one of its stock index funds, Vanguard lists an expense ratio of
0.05 percent. State Farm lists it at 0.76 percent for a similar fund.
The ratio jumps to 1.73 percent for a Nasdaq-based investment managed by
ProFunds.
"ProFunds are not typical index mutual funds but are designed for
tactical investors who frequently purchase and redeem shares," said
ProFunds spokesman Tucker Hewes. "The higher-than-normal expense ratios
of these non-typical funds reflect the additional cost and efforts
necessary to manage and operate them."
Average fees also tend to vary based on the size of an employer's
401(k) plan. The total management costs for individual companies with
plans with more than $1 billion in assets has averaged 0.35 percent a
year, according to BrightScope, a firm that rates retirement plans. By
contrast, corporate plans with less than $50 million in assets have
total fees approaching 1 percent.
Higher management costs do far more to erode a typical American's
long-term savings than does the high-speed trading highlighted in
Michael Lewis' new book, "Flash Boys." Kinnel said computerized trades
operating in milliseconds might cost a mutual fund 0.01 percent during
the course of a year, a microscopic difference compared with yearly
fees.
"Any effort to shine more light (on fees) and illustrating that
impact is huge," Kinnel said. "Where we've fallen down most is not
providing greater guidance for investors in selecting funds."
The Investment Company Institute, a trade group, said 401(k) fees for
stock funds averaged 0.63 percent in 2012 (lower than the 1 percent
average figure the Center for American Progress uses), down from 0.83
percent a decade earlier. The costs fell as more investors shifted into
lower-cost index funds. They've also declined because funds that manage
increasing sums of money have benefited from economies of scale.
"Information that helps people make decisions is useful," said Sean
Collins, the institute's senior director of industry and financial
analysis. "Generally, people pay attention to cost. That shows up as
investors tend to choose — including in 401k funds — investments that
are in lower than average cost funds."
But many savers ignore fees.
In a 2009 experiment, researchers at Yale and Harvard found that even
well-educated savers "overwhelmingly fail to minimize fees. Instead,
they placed heavy weight on irrelevant attributes such as funds'
(historical) annualized returns."
The Labor Department announced plans last month to update a 2012 rule
for companies to disclose the fees charged to their 401(k) plans. Fee
disclosures resulting from the 2012 rule proved tedious and confusing,
said Phyllis Borzi, assistant secretary for the Labor Department's
Employee Benefits Security Administration.
"Some are filled with legalese, some have information that's split between multiple documents," Borzi said.
Americans hold $4.2 trillion in 401(k) plans, according to the
Investment Company Institute. An additional $6.5 trillion is in
Individual Retirement Accounts.
For years, companies have been dropping traditional pension plans,
which paid a guaranteed income for life. Instead, most offer
401(k)-style plans, which require workers to choose specific funds and
decide how much to contribute from their pay. Workers also bear the risk
that their investments will earn too little to provide a comfortable
retirement.
The shift from traditional pensions threatens the retirement security
of millions of Americans. Many don't contribute enough or at all. Some
drain their accounts by taking out loans and hardship withdrawals to
meet costs. Sometimes their investments sour. And many pay far higher
fees than they need to.
Of all those problems, fixing the fees is the easiest, Center for
American Progress researchers Jennifer Erickson and David Madland say.
They are calling for a prominent label to identify how a plan's fees
compare with low-cost options. That information, now found deep inside
documents, shows the annual fees on investing $1,000 in a plan. Yet that
figure, usually only a few dollars, doesn't reflect how the fees rise
into tens of thousands of dollars as the account grows over decades. The
researchers say the Labor Department could require more explicit
disclosure without going through Congress.
Part of the blame goes to employers that offer workers high-fee plans.
"The good options are out there," said Alicia Munnell, director of
the Boston College's Center for Retirement Research. "But when you
introduce bad options into a plan, you attract people to them. There are
a lot of people who think they should buy a little of everything, and
that's diversification.
"I want the world to know that fees can really eat into your retirement savings."
May 2008
Kiplinger - Any way you figure it, Steve Jeffers is a formidable investor.
For 18 years now, the Belpre, Ohio, plant manager has been diligently
stashing money in the 401(k) plan of his employer, Kraton Polymers.
Thanks in part to a generous match by Kraton, the 43-year-old Jeffers
has amassed almost $400,000.
Yet Jeffers didn't have a clue what his 401(k) investments were
costing him -- and neither, we wager, do you. A recent AARP study found
that more than 80% of 401(k) plan participants were unaware of how much
they were paying in fees associated with their company's retirement
savings plan. And what you don't know, you can't change.
Mutual fund returns in 401(k) plans are normally reported as net
returns, meaning that fees for managing your investments are subtracted
from your gains or added to your losses before calculating the annual
return. Other costs, such as administrative and record-keeping fees, are
often divvied up among plan participants but are not explicitly listed
on individual investment statements.
This lack of transparency is frustrating for investors like Jeffers.
He has concentrated his investments in global stock and bond funds that
have significantly outperformed Standard & Poor's 500-stock index in
recent years. "I don't mind paying fees if the returns justify it,"
Jeffers says. "But it would be nice to know what I'm paying."
That's not an easy question to answer, even for an investment
professional such as David Loeper. "It involves more than just looking
at your statement," says Loeper, who heads an investment-consulting firm
in Richmond, Va. "Under the expense column, my 401(k) statement said I
was paying zero. But in reality, I was paying about $1,500 a year on an
account balance of about $120,000, even though the bulk of my
investments were in very low-cost index funds."
Once Loeper figured that out, he switched 401(k) providers for his
small company of 25 employees to a less expensive vendor. He also wrote
Stop the 401(k) Rip-off! (Bridgeway Books, $15.95;
401kripoff.com) to help people like Jeffers figure out how much they're paying, whether the fees are fair and what to do if they're not.
1. Add fund expenses charged to your 401(k)
These charges, which go to the companies that manage your plan investments, are typically the largest 401(k) fees you pay.
To estimate your direct investment expenses, look for the
expense ratio for each fund you own. That figure may be listed on your
401(k) plan Web site, or you can find it at
kiplinger.com/tools/fundfinder. Expense ratios are expressed as an annual percentage of your total investments.
Next, grab your most recent 401(k) statement and record the
expense ratio next to the balance in each fund you own. Multiply the
expense ratio by your ending balance to determine the cost of each fund.
For example, if you have $10,000 in a fund with an expense ratio of
0.55%, you are paying $55 a year. Add up the expenses for all of your
funds.
A total expense ratio of 1% or less is reasonable. When we calculated Jeffers's fees, they totaled roughly $4,000, or about 1% of his 401(k) balance.
If your 401(k) plan uses a broker or investment consultant, as many
smaller plans do, you may be charged an additional 2% or more in
portfolio-management fees. Teachers and other employees of nonprofit
organizations who save for retirement through 403(b) plans may pay
additional mortality charges and expenses to insurance companies, which
typically provide annuities as investment options.
2. Determine if plan operating expenses are passed on to your 401(k)
You may also be paying your share of what it costs your employer to
operate the 401(k) plan. Bigger companies often pick up plan expenses on
behalf of their employees, but smaller employers can't always afford to
do that. Still, for most 401(k) participants, the fees are less than
they'd pay investing on their own, says David Wray, president of the
Profit Sharing/401(k) Council of America.
Get a copy of your plan's summary annual report from your
benefits office. Under the section labeled "basic financial statement,"
look for total plan expenses and subtract the amount of benefits paid.
The difference is the plan's net administrative expenses.
Next compute your cost for administrative expenses, divide the
net expenses (for instance, $12,000) by the total value of the plan
(let's say $1.5 million). Multiply that percentage -- which is 0.8%
(.008) in this example -- by your total account balance. That will give
you your share of total plan expenses that are deducted from your
account before your individual balance is calculated.
3. Investigate undisclosed or hidden costs
You could be funding your boss's retirement or that of a colleague in
the next cubicle without realizing it, says Loeper. That's what happens
when your plan's service provider and individual mutual fund companies
engage in "revenue sharing" arrangements. Such agreements are seldom
disclosed; even your employer is unlikely to be aware of them.
For example, some high-cost funds may offer a rebate to the service
provider to defray overall operating expenses. So the excess fees that
you pay for your fund are used to pay the costs for everyone else in the
plan. Or your plan's provider may receive commissions from mutual fund
companies to steer participants into higher-cost funds.
- A 1 percentage point difference in fees can radically reduce savings.
- So-called no-load funds can charge up to 0.25 percent in sales fees.
- Get a handle on the various fees that siphon assets from your account.
July 13, 2009
Bankrate.com - The
stock market isn't the only thing that can shrink your retirement
funds. From advisory fees to trading costs, the fees siphoned from your
retirement account could add up to 3 percent, and even 5 percent of your
account assets annually, says Daniel Solin, author of "The Smartest
401(k) Book You'll Ever Read." For investors, these seemingly modest
fees add up to big bucks.
Just a 1 percentage point difference in
fees can dramatically reduce the size of your nest egg over time. For
example, a worker who saves $5,000 a year for 35 years and earns an
annualized 8 percent return net of fees would end up with $861,584 --
versus $691,184 for someone who earns 7 percent after fees. That amounts
to a 25 percent reduction in wealth for the worker with higher fees.
While Congress is currently considering legislation that would require
greater fee disclosure and the inclusion of a low-cost index fund option
in a 401(k) plan, right now most plan holders have to dig deeply to
find out how much they're forking over -- and they still may not know
despite their due diligence.
To make sure your plan pays off, take these steps to try reducing or eliminating these five fees.
Administrative fees
The
Investment Company Institute, a Washington D.C.-based nonprofit that
represents the mutual fund industry, reports that three fees comprise
approximately three-quarters of the total expenses in 401(k) plans:
administrative, investment management and distribution fees.
Also
known as account maintenance charges, administrative fees pay
bookkeepers, trustees and legal advisers that keep your account running.
While almost every major type of retirement vehicle (including IRAs)
comes with some plan administration fee, Mike Alfred, co-founder of the
retirement plan rating company BrightScope, says savers rarely know how
much they're paying.
"If a plan is outside a 401(k), you can
usually see what fees you're paying," says Alfred. "If you're in a
401(k), it's virtually impossible for the average consumer to get data
on what administrative fees they're paying because companies aren't
required to disclose that information."
According to the
Investment Company Institute, the median fee for administrative,
recordkeeping and investment-related services on 401(k) plans is 0.72
percent of total assets -- approximately $346 per year for the average
401(k) participant. One out of every 10 plans charges 1.72 percent or
higher.
While one in four employers foot that bill on
company-sponsored plans, according to a study by Hewitt Associates, most
workers pay up themselves.
To make sure your administration fees
are at or below average, Alfred recommends talking to your human
resources representative. Employees may be able to compare their
company's 401(k) investment and administrative fees to that of
competitor companies at
Brightscope.com.
Management fees
Also
called investment advisory fees, management fees pay those who operate
the mutual funds in which you invest your money. According to Solin, the
amount you pay in management fees depends largely on how much
management your specific investments require. Actively managed funds
that employ live experts to personally choose stocks in hopes of gaining
higher returns generally charge significantly more than passively
managed index funds that mimic such benchmarks as the Standard &
Poor's 500.
"Index funds usually have fees around 0.25 percent,
but the fees for actively managed funds average 1.5 percent," says
Solin. "That's a big difference."
Solin adds that actively managed
funds usually don't perform better than their cheaper index
counterparts. A 2008 study by Standard & Poor's Index Services
reveals that the S&P 500 outperformed three out of every four
actively managed funds during the previous five years.
While
workers in company-sponsored plans that offer index funds can smoothly
transfer their money into these funds, some plans don't offer index
funds. Workers may want to consider lobbying their employers to add
passively managed options to their lineup.
"Complain
to the human resources department and say, 'Why do we have a plan that
is populated with funds that history tells us will underperform index
funds?'" says Solin.
As noted earlier, Congress may soon require companies to include at least one low-cost index fund in their plans.
Distribution Fees
Distribution or service fees are perhaps
the most controversial of fees charged by fund firms. Designed to help
mutual fund firms market mutual funds and to compensate brokers and
advisers who sell them, distribution fees, commonly known as 12b-1 fees,
can range from reasonable to out of control. They can eat up a
significant chunk of your profits.
"Certain mutual funds come
with 12b-1 fees that can run anywhere between 25 basis points (0.25
percent of assets) and 1 percent," says Bill Hayes, managing director of
asset management for the Chicago Investment Group. "If you're happy
with the way your account is performing, a 12b-1 fee isn't too bad to
pay, but you can also opt for funds that don't have them."
Instead
of forgoing 12b-1 fees entirely, Hayes recommends carefully monitoring
how much you're paying in distribution fees and evaluating "no-load"
investment options that don't incur 12b-1 charges.
While no-load
funds generally do not charge loads, be aware that they can legally
charge up to 0.25 percent in 12b-1 or shareholder service fees without
losing their no-load moniker. But not all no-load funds charge these
fees.
Early withdrawal and surrender charges
Another
way consumers lose money is by pulling funds out early. Withdrawals from
401(k), 403(b) and IRA plans result in a 10 percent penalty if made
before you reach the qualified retirement age (usually 59½, though it's
age 55 in certain instances with company-sponsored plans).
It's
true that from traditional and Roth IRAs, consumers can withdraw funds
fairly easily to buy a first home ($10,000 limit per person), pay for
college, or defray disability costs, medical expenses or health
insurance premiums if unemployed. This they can do penalty free, though
income taxes will be due in the case of withdrawals from traditional
IRAs.
But penalty-free withdrawals from company retirement plans
are allowed only under extreme circumstances such as total disability,
medical expenses that exceed 7.5 percent of adjusted gross income,
losing employment after age 55 or receipt of a court order to hand money
over to a divorced spouse.
With 403(b) plans -- retirement plans
generally offered at schools and nonprofits -- an extra caveat is
warranted. These plans often hold variable annuities, insurance products
that usually charge surrender fees on top of the 10 percent penalty.
"Surrender
charges can be avoided if investors understand how much liquidity they
can take out of their accounts and the time frame their policy
requires," says Dan White, head of the Glen Mills, Pa.-based retirement
planning firm Daniel A. White and Associates. "Most long-term plans
allow people to withdraw up to 10 percent of their account without
penalty."
White adds that while annuity restrictions vary from
company to company, most contracts require holders ages 59½ and older to
invest for a minimum of five to eight years, but allow them to withdraw
anywhere from 5 percent to 15 percent of the account value annually
without penalty. Those who pull out earlier may pay a surrender charge
of up to 10 percent on top of penalties and taxes on earnings. The
surrender fees recede over time, so the longer you hold an annuity, the
lower the surrender charge will be at withdrawal.
Trading costs
Those
who own a brokerage account or act as their own account manager by
trading stocks can lose a lot of money by overpaying trading costs and
brokerage fees.
"Without a broker, people should expect to pay
$7 to $10 a trade," says White of Daniel A. White and Associates. "And
with a broker, they can expect to pay $40 or $50 a trade. A lot of
places charge $100 a trade and that's just ridiculous."
White
advises those who play the market to shop around for an online trading
firm that offers discounted trades. TradeKing.com and Zecco.com offer
trades for as low as $4.95, for example. When it comes to finding a
broker, White recommends consumers comparison shop before settling.
"People
usually don't start looking at how much the fees actually cost until
they start losing money," White says. "That's when it really starts to
hit home."
