Despite what new 401k investors might think, 401k plans aren’t free.
In fact, it’s just the opposite.
401k plans are loaded to the brim with fees, including front and backload fees, 12b1 fees, and investment management expenses. Hey, you can’t expect fund companies to manage billions of dollars in 401k plan money out of the goodness of their hearts.
The problem is, some 401k fund fees are so high, they can significantly impact fund performance. According to a paper by Ian Ayres and Quinn Curtis, "Beyond Diversification: The Pervasive Problem of Excessive Fees and Dominated Funds in 401(k) Plans," reports that those “fees were so high (compared with an index fund) in 16 percent of the plans that, for young employees, these fees consumed “the tax benefit of investing in a 401k plan.”
In addition, 52 percent of 401k plans had mutual funds that were “more expensive” than comparable funds, due to higher fees.
In a separate study, entitled "Measuring Fiduciary and Investor Losses," the same authors had found that participants would have earned returns 23 percent higher if they had invested “optimally without menu restrictions or fees.”
The reality is, though, that most plan participants don’t even know they are paying 401k fees. But many mutual fund providers charge more than 1% of your total assets in investment management fees.
That means if you a 401k plan valued at $250,000, you’re paying $2,500 or more strictly for the privilege of having your money managed by a mutual fund company – usually a big one. And that’s too much money, in my opinion.
The goal for 401k plan participants is always to achieve maximum outcomes with their plans – i.e., save enough for a comfortable retirement.
But that goal can be achieved more quickly if you curb your retirement plan fees, and keep more of those costs in your own pocket, and in your own financial future.
Start by reviewing your 401k plan packet – if you don’t have one, your human resources contact should be able to provide one for you. That 401k fund packet should include all fees being charged for you to participate in the plan.
Next, get to know the specific fund fees.
Here’s a rundown of key 401k plan expenses. Review them thoroughly, and ask your human resources contact or plan sponsor representative what you can do to lower them – as soon as possible:
Back-end load – This is the redemption charge investors pay when making a cash withdrawal from his or her 401k plan. It’s usually associated with fund redemptions.
Contractual plan fees – This is a plan designed for periodic fixed dollar investments over a specified period of time, such as 10-15 years. A substantial portion of the total investment fee charge is usually deducted in the early years of the plan timeframe.
Front-end load – A sales charge applied to an investment at the time of initial plan purchase.
Management fee – The amount charged against investor assets for investment advisory services. The standard industry mutual fund management fee is between 0.5%-and-2% of total fund assets.
Sales charge – Also known as the sales load. This is the fee charged on an investment, and it varies according to the fund and the investment. The charge is added to the net asset value of the fund.
Transaction costs – These are costs incurred from the buying and selling of fund securities. They include brokers’ commissions and “dealer spreads” – the difference between the price the dealer paid for a security and the price the security can be sold.
12b-1 fees – These are the fees mutual fund firms charge 401k plan participants for the costs they incur marketing their funds, specifically advertising and marketing costs (such as the 401k plan newsletter you probably get from your plan sponsor.)
Actionable Step: Make sure to cover all of the above fees with your company, or with your plan sponsor. Not all 401k fees are created equal, and you could be selling your financial future short by loading up on funds with big fees.
Ask what your employer or plan provider can do to cut those fees, and see if that doesn’t make a difference down the road with your total plan assets.