“My 401(k) costs money?!” If that’s the first thing that popped into your mind after reading the title of this article don’t fret, you’re not alone. A Study by AARP found that seven out of ten (70%) people who participated in a 401(k) thought that the program was free to them. However, there are actually a number of fees that come straight out of your account and they all might not be as easy to detect as you would imagine.
For most 401(k)s, there are typically two basic areas where fees come from: Investment options and Recordkeeping/Administration. Let’s dig a little deeper into each of these to get you a better picture of how things work.
Recordkeeping and Administration
Your plan’s record keeper is the big company that sends you your statements. They offer and control the platform your plan is being administered through. They typically charge based on the number of participants or plan assets. Thankfully for us, recordkeeping and administration fees have been on the decline for several years. Most employers cover most of these fees, leaving only a small portion to be paid by participants on a quarterly basis. These fees are used to pay for those boring administrative things that go on behind closed doors such as non-discrimination testing, the website you view your account on, and tons of other things that you probably never realized were apart of operating a retirement plan.
These are a little bit more complex. There are fees you pay for investment options such as Mutual Funds and ETF’s, expressed as an ‘Expense Ratio’ or exp ratio in the fine print of the fund’s prospectus. There are fees for investment advisors who oversee the plan’s investment options or offer advice and participant education and these are typically charged as a cost per participant or as a percentage of assets.
Here is where it gets a little bit sneaky on behalf of the investment and recordkeeping companies. There is a thing called revenue sharing that allocates a portion of an investment option’s expense ratio to the recordkeeping company. This kickback is totally legal. However, with these types of funds you are essentially double paying the record keeper for services that are already being rendered to you. But for the second payment it’s an asset based fee because it comes out of the funds expense ratio. That’s like dropping off your car at the mechanic for an oil change and being charged the cost of the oil change and for the amount of time you’ve left your car there. In your 401(k), when you contribute to funds that are a part of a revenue sharing scheme it costs you more money to contribute every time you contribute. What’s especially slippery about these revenue sharing agreements is that the cost is practically hidden from you. Because it’s built into the expense ratio of the fund, it is assessed through the Net Asset Value of the investment and this allows for it to be easily hidden or disguised on paper.
Small fees may not seem like a big deal. You might hear 1% or 2% and say “Oh well, I guess that’s just the cost of contributing!” You wouldn’t be wrong, but you also wouldn’t be right. While minuscule, do you really want to overpay for anything, especially with your retirement money? Here’s the hard and scary truth. A 1% increase in fees can reduce the value of your retirement account by 28% over your working life.
Now you’re probably thinking “What can I do to bring my fees down?!” Well, I’m glad you asked, let’s talk about how you can avoid those sneaky revenue sharing funds and lower the overall cost of your retirement account.
Review Your Fund’s Prospectus
Make sure the funds you’re putting your money in have a reasonable expense ratio. If you work for a smaller employer make sure there are not front-end, back-end or redemption fees. If there are, see if your employer covers those for you. Make sure that the investment choices in your plan are class acceptable. If your plan has ‘A’ Shares and the prospectus shows that there are cheaper share-classes available go ask why your plan isn’t using them.
Increase Your Contributions
Contributing to your retirement plan is important already, but contributing more could give you the leverage you may need to get access to lower cost funds. Compounding extra savings with lower expenses makes for a better ending to your story!
Choose Index Funds
Index funds track an index like the S&P500 or the Dow Jones. They’re a passive strategy that offers the lowest cost strategy available. Typically expense ratios of Index funds are less than .08%. Index funds are great choices for those who are not savvy investors or don’t want to lie awake at night thinking about the balance of their 401(k).
Here at Plancheckr we don’t recommend investments or promote recordkeeping companies. We’re here to make sure that your retirement plan flows smoothly and that your plan is protected. Plancheckr is a fiduciary tool and the people who use it are passionate about the retirement space and the people they serve. If your plan advisor uses Plancheckr, go ahead and take a sigh of relief.