Take steps to curb retirement plan fees
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.
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.
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 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.
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.”