Fees can ravage retirement plan

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Some 401(k) plan participants don’t get mad about fees. They get even. Such was the case with workers at Bechtel Corp., a privately owned firm in the engineering, construction and project management business.

Recently a U.S. District Court judge approved an $18.5-million settlement by Bechtel in an excessive 401(k) fee lawsuit filed by employees. The lawyers representing the plaintiffs will get nearly $4.9 million of that, plus $1.57 million to cover their costs. The balance will get spread among the plan participants, “generally pro-rata based on balance,” says Nevin Adams, an attorney and editor-in-chief of Plansponsor.com. “They don’t usually wind up with all that much,” he adds, referring to the rank and file.

The problem: Bechtel’s plan offered retail mutual funds rather than institutional funds. The latter are generally only accessible to investors with large minimum amounts to invest. That mostly means pension plans as well as 401(k) plans, which pool millions — and sometimes billions — of dollars in a plan.

Bechtel has more than 17,000 participants in its 401(k) plan, and while no one will get enough funds to afford an immediate exit from the 9-to-5 grind, the employees had their day in court and were rewarded for their efforts.

Other company suits

The fiduciaries in charge of a company plan ought to know that they can ask for fee waivers or for admittance to a particular share class. Bechtel isn’t the only company to have made this faux pas. Last year, Caterpillar agreed to a $16.5-million settlement and General Dynamics to a $15.1-million settlement in their respective excessive 401(k) fee suits.

Last week in a blog titled “Does the 401(k) deserve an F?,” I mentioned that 401(k) plan fees have been difficult to figure out, but next year this information will be accessible to plan participants, thanks to new regulations that go in effect January 2012.

Most people don’t realize they’re paying fees. They’re not only paying fund expenses, but they may also be forking out money for 12b-1 fees, record keeping and accounting fees, trustee-custodian fees, sales charges, legal and auditing fees — the list goes on. On top of that, revenue-sharing agreements and soft-dollar arrangements are common, and these are difficult to calculate, much less disclose.

A fee primer

So, expense ratios of mutual funds are only part of the costs. These include the fund operating expenses, such as legal, accounting and auditing fees, and 12b-1 fees if applicable, that are levied by the investment firm managing the fund. They are expressed in percentage terms (total expenses divided by the fund’s average net assets). They are siphoned out directly from fund assets, so you never even notice the loss.

Here’s the breakdown of average expense ratios for retail funds versus institutional funds:

Retail funds vs. institutional funds
Fund type Average expense ratio
Retail stock funds 1.55 percent
Institutional stock funds 0.99 percent
Retail bond funds 1.16 percent
Institutional bond funds 0.64 percent
Source: Morningstar

What’s the big deal?

The expenses may seem small to the uninitiated. There’s a 56-basis point differential between retail and institutional share classes. So what? Ditto for bond funds — a 52-basis point difference.

But over time, 50-odd basis points can makes a big dent in your retirement savings.

Retirement planning calculations are more complicated than this, but let’s keep it simple and imagine you invest $500 per month throughout your career. Your average annual return is 8 percent in this hypothetical example, minus fund expenses.

After 30 years, you will have amassed $547,745 had you invested in retail stock funds charging 1.55 percent annually. But if you had invested in institutional stock funds charging 0.99 percent, your nest egg would be worth $611,190, or $63,445 more. That’s enough to pay for cable and the occasional dinner out on the town.

Which nest egg would you rather own?


Check out Bankrate’s Retirement Realities series. We’ll be adding stories to it throughout the year.

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Written by
Barbara Whelehan
Contributing writer
Barbara Whelehan is a contributing writer for Bankrate. Barbara writes about a range of subjects, including homebuying, real estate, retirement, taxes and banking.