401(k) plans are the primary retirement savings vehicle for millions of Americans. But many participants don't realize how much of their account balances are going into the pockets of plan providers and custodians in the form of annual fees and other expenses.
Those fees can significantly erode the returns posted in the plans over time, and the issue has come to the forefront of regulatory oversight in recent years because of growing consumer complaints and legal actions. In fact, a whopping 11 class-action lawsuits were filed against 401(k) plan providers in the last quarter of 2015 alone.
Here's a rundown on the fees associated with 401(k)s and what you can do to make sure those you're paying are not excessive. (For related reading, see: The 401(k) and Qualified Plans: Introduction.)
Know What You Are Paying
Many plan participants have no idea how much they are paying in fees in their employer-sponsored retirement plans. They do matter. A 1% increase in the fees charged on an annual basis over a long period of time can reduce your plan balance by a whopping 28% at retirement. And there are several different types of fees that these plans can charge, including:
- Investment management fee. This is used to pay the portfolio managers who run the mutual funds in which you are invested. It is usually charged on a monthly or quarterly basis.
- Administration fee. This fee may be charged as a dollar amount directly from your account balance on a quarterly, biannual or annual basis. It goes to the custodian of your plan in return for their services, such as holding the funds and keeping records.
- Sales charge. Many of the mutual funds found in 401(k) plans are traditional open-ended funds that assess a sales charge either when they are purchased or when they are redeemed. This charge is levied on top of the annual fees of the fund and the plan administration fees.
- Mortality and expense charges. If your 401(k) plan is invested in a variable annuity contract, you will pay this fee for the cost of insuring your plan through the carrier. You may also pay additional charges for living and death benefit riders that can provide guaranteed streams of income at retirement or a guaranteed minimum account balance to your heirs. (For related reading, see: Feex: A Tool to Reduce Investment Management Fees and Mutual Funds: Management Fees vs. MER.)
Federal regulations now require all 401(k) plan sponsors to provide their participants with written disclosures that list all fees that they are paying in their retirement plans. Unfortunately, there is no standard format for this disclosure, so it can be difficult to read and understand, and some can run to 20 to 40 pages. But it’s vitally important that you understand how much of your retirement savings is being eaten up by these fees, and it is worth your while to read through it in order to find these numbers, which may be buried in the fine print.
What You Can Do
If your retirement plan is invested in mutual funds that assess sales charges or a variable annuity contract, then chances are that you’re paying anywhere from one to three percent a year in fees. And while the high end of those fees will probably get you a guaranteed income payout based upon a hypothetical rate of growth, you may be better off simply putting your money in low-cost index funds that simply buy the major market indices. These funds usually don’t come with sales charges and often have very minimal annual fees because they are not actively managed. (For related reading, see: Understanding Mutual Fund Fees.)
Reams of historical data show that it is virtually impossible to beat the markets with active fund management over time, so index funds may be a viable alternative for your retirement funds. Ask your employer whether this type of fund is available in your plan, and don’t be afraid to ask whether one or more can be added if they are not.
You can also buy ETFs that invest in the market indices if you have a self-directed brokerage account available in your plan. Just be aware of how much you pay in commissions to buy and sell your funds or other investments. Don't succumb to the temptation to try to time the markets. History shows that this is generally a futile effort.
The Bottom Line
Finding out how much you are paying for your 401(k) plan takes some research, but you should know exactly what you are getting for your money. Investing in a variable annuity with higher fees may be justified in some cases, as long as you have a clear picture of what it is costing you. (For related reading, see: 5 Signs Fund Fees Are Hammering Your Investments.)