401(k) Fees: Know What You're Paying, What You're Getting

There's an old joke on Wall Street that goes something like this:

Financial adviser to client: "I've reviewed your financial picture, and if we manage your money properly, there should be plenty for both of us."

So it goes in the 401(k) market, where the fees you pay to the advisers who manage your plan can mean the difference, financially speaking, between a so-so retirement and a great one.

Check out the scenario laid out by the U.S. Employee Benefits Security Administration: For someone with 35 years until retirement and a 401(k) plan valued at $25,000, fees can make a big difference. If the investments in such an account return 7% annually and fees are 0.5% of all plan assets, that 401(k) plan will grow to $227,000 by the time the recipient hits retirement age�even if the recipient doesn't drop a single additional dime into the plan.

Sounds pretty good, right? But what if the 401(k) plan fees are 1.75% instead of 0.5%? Then the retirement landscape isn't so bright. Instead of $227,000, the plan participant would only earn $150,000. The 1.25 percentage point difference in fees cuts more than $77,000 (34%) of the 401(k)'s account balance at retirement.

You'd think that investors would be clamoring for more information about 401(k) fees. But that's not the case. According to a recent survey from AARP, a whopping 83% of 401(k) plan participants had no idea what they paid out in plan fees and expenses. And about half of the survey respondents weren't aware of the impact that fees had on their 401(k) plan's value.

Imagine if the waitress at your local diner added a 28% "service" fee to your scrambled eggs. Or if the barkeep down at your favorite pub tacked a similar fee onto your favorite brew. You'd be upset and rightly so. But Wall Street does such a good job of hiding its 401(k) plan fees that few people realize the impact on the value of their plans�their financial lifeline during retirement.

The good news is that you have some leverage in determining your 401(k) plan fees. The path to using that leverage is through some straightforward education. Let's take a look.

Types of fees

Administration fees�Someone has to manage the books, so paying for record-keeping, accounting, tax and legal services, and trustee services are par for the course with 401(k) plans. Bundled into those fees are new-age fees for things like retirement planning software, online customer service, and periodic and increasingly popular "Webinars"�education seminars delivered to plan participants over the Internet.

Your employer may or may not contribute to the plan provider's administrative fees. Make sure you ask your human resources contact whether your company is paying such fees or not. If so, ask how much.

Investment fees�Executing trades, making portfolio allocation decisions, deciding when to buy and when to sell, and monitoring your investments and the financial markets all fall under the auspices of "investment fees." You're not charged on a dollar basis, per se, and you won't find itemized investment fees on your quarterly plan statement. Investment fees are more of an indirect fee tied to a percentage of your total assets. Most fall into a range between 0.5% to 2% of plan assets. Note that even if your 401(k) plan loses money, investment fees�in fact, all fees�are still in play.

Your human resources department can answer many questions regarding how fees affect your plan.

A la carte fees�Also known as individual service fees, these fees are for services that go above and beyond the basic accounting or investment fees incurred with your 401(k) plan. If you have to borrow from your 401(k) plan, a handling fee is incurred in the transaction. Much like banking fees, any special services required for your account usually will incur some kind of fee.

Steps to take to reduce your 401(k) fees

Now that you know what you're up against, these steps can help you minimize the negative impact that fees can have on your plan performance.

Talk to your employee benefit representatives�Your human resources department or employee benefits representative can answer many questions regarding how fees affect your plan. Ask how much you're paying in fees and, if those fees seem high (usually 1.75% of your plan assets or higher), ask if there are better plans available with more competitive fees. Employers, despite popular perception, do listen to their staffers, especially when it comes to benefits. You do have a say, so use it.

Ease fees on your own�Avoid heavy service fees by avoiding fee-triggering behaviors linked to your 401(k) plan. Taking loans is a no-no for many reasons. Among those negatives are handling fees for processing your hardship loan.

Load up on no-load funds�Check your 401(k) plan package, or ask your benefits rep, to see what investment choices are in your 401(k) plan. Chances are you have a few no-load mutual fund options available. No-load funds significantly decrease the investment fee portion of your plan's fee structure.

Turn to index funds�Like no-load mutual funds, index mutual funds offer much lower investment and administrative fees than traditional mutual funds. Most mutual funds are "actively managed"�meaning some fund company egghead is making hands-on decisions every day regarding your fund. Index funds are "passively managed"�meaning they are created to mirror a key financial index like the Russell 2000 or the Dow Jones Industrial Average Index. Whatever the Russell index or the Dow Jones does, that's pretty much how your index fund will do. Consequently, index funds are simple and much more fee-friendly.

Get involved�If you're feeling ambitious, write your elected representatives in Washington and tell them you want Wall Street to start clearly noting all of its 401(k) plan management fees. Right now, you just about need an economics degree to figure out what you owe in plan management fees.

Published December 10, 2007