401(k) Fees Can Chomp a Hole in Your Savings

USA Today, Managing Your Money
The 21st Century Retirement
Charges can be hard to find
by Kathy Chu, USA Today

Do you know what you're paying for your 401(k) plan?

If you're like most employees, you don't have a clue. But you should, because high fees can shrink your retirement savings and endanger your financial security.

Retirement-plan fees have drawn more attention in recent years as the oldest of 79 million baby boomers get set to retire. Now, this scrutiny is reaching a critical mass. The Labor department is considering requiring companies to disclose more information about retirement plan fees. Meanwhile, individual lawsuits, filed this year against companies including Lockheed Martin and Boeing, allege that employees were overcharged in their 401(k) plans.

The fees charged in 401(k) plans are all but invisible to investors who don't know where to look. Making matters more confusing are complex fee arrangements common in retirement plans that often lump together administrative and fund-management fees. Regulators are studying whether these arrangements inflate retirement-plan fees by making it hard for you to figure out how much individual services cost.

"If employees are paying more (than they need to), they have less money in their account to buy groceries when they get old and can't work anymore," says Ward Harris, CEO of The McHenry Group, a financial consulting firm.

Because 401(k) accounts are often held for decades, and many people make minimal changes in their fund choices, high fees can drain significant money from a retirement nest egg over time. The impact may surprise you.

Let's say you have 35 years until retirement, a 401(k) balance of $25,000 and an average 7% return on investments per year. If fees shave a half-percentage point off returns, you'll have $227,000 at retirement (assuming you didn't contribute anything past the $25,000), according to the Labor Department. By comparison, if fees cut into returns by 1.5 percentage points, you'd end up with $163,000.

To gauge the effect of fees on your 401(k) investments, try to pull together these documents: mutual fund prospectuses, annual account statements and the 401(k) summary plan description.

Don't expect this to be a quick exercise. The summary plan description will likely have to be mailed to you. It contains information about the plan investments, and often, about whether administrative expenses are deducted from fund performance, covered by the employer or charged to participant's accounts.

The prospectus will show the fund's average expense ratio, which signifies fees taken out of assets. The account statement will detail other charges, such as accounting or legal costs, that might be deducted from your account.

The main types of 401(k) fees and how you can minimize them:

Investment expenses
These are, by far, the biggest expense workers face in retirement plans; the make up as much as 80% of a 401(k) plan's total cost.

The cost of operating and managing a mutual fund is reflected in the expense ratio, which is a percentage deducted from the fund's total return. If a fund returns 7% a year, and the expense ratio is 1% investors' net return would be 6%.

One way to see whether you're paying too much is to compare the expense ratio and performance of 401(k) investments with those of similar funds outside the plan.

"If the funds in the 401(k) plan are not producing a decent return, that could be a sign that fees are excessive," says Jerome Schlichter, founding partner at Schlichter Bogard & Denton law firm.

Consider whether you could reduce fees by switching to other investment options. Large employers may offer institutional shares of mutual funds in their 401(k) plans. The cost of such shares generally falls as assets rise in the plan.

Also check out low-cost index funds, whose holdings mirror a broad stock index. Index funds tend to be much cheaper than actively managed funds because they have a lower turnover of assets and require less research and monitoring.

Index funds tend to outperform actively managed funds. Over a 10-year period that ended Oct. 31, the average index fund returned an annualized 8.7% (after expenses) compared with 7.2% for an actively managed fund, according to investment-research firm Morningstar.

Administrative costs
Administrative fees for online account access, educational seminars on investing and other services are often tacked onto fund-management fees and deducted from fund assets in a 401(k) plan.

Employers aren't required to provide you with written information about what portion of a fund's expense ratio comes from administrative fees. But they should be able to tell you this information verbally or find it out for you. By law, employers must make sure retirement-plan fees are "reasonable."

Few employees question fees. That's a key reason employees are increasingly bearing more of the administrative expenses in 401(k) plans, according to Pamela Hess, director of retirement research for Hewitt Associates. Hewitt's research shows that, in the past few years, more employers have shifted the cost of plan mailings, educational seminars, investment advice and even retirement-plan design to employees.

Still, some employees are wising-up to 401(k) fees. Schlichter has sued on behalf of workers at Boeing and Lockheed Martin, among others, charging that retirement-plan fees paid by employees are "unreasonable and excessive." The law suits allege that employers failed to "properly" inform employees about fees. Boeing says it believes its saving plan "meets all legal requirements;" Lockheed Martin says the lawsuit is "without merit."

Individual service charges
If you want to borrow from your 401(k) plan or keep money in it after leaving the company, you might have to pay extra. Employees may also foot the bill for hardship withdrawals or to have retirement funds wired to their bank accounts. For more information about 401(k) fees, check out the Labor Department's checklist at www.dol.gov/ebsa; click on the publications tab.

You usually can't negotiate lower fees on these services. But if you know in advance the fee for, say borrowing from your nest egg and when you'll have to pay the money back, you can figure out whether you're better off tapping another source of money.

If your retirement plan offers mediocre investments or the fees are too high, it can't hurt to lobby your employer to make changes.

"If employees started looking at (the plan) and asking questions, there's no question that employers would re-evaluate it," says Dallas Salisbury of the Employee Benefit Research Institute. "Employers are worried about litigation."