How many of you would guess that over the lifetime of your 401k plan hidden fees could cost you more than $150,000? That’s the conclusion Demos, a non-partisan policy research and advocacy organization, came to in a recent research paper. The vast majority of employees participating in 401k plans across America have no idea about the variety or amounts of fees that they are paying, but that’s about to change. The Department of Labor, beginning July 1, will require plan administrators and employers to implement new disclosure rules for plan participants that will help shine a light on what has been a dark secret.
Fees fall into four broad categories:
- Administrative fees. These include record-keeping, investment statements, regulatory compliance and customer service including development & maintenance of plan website. These fees typically cost .2% to .4% annually.
- Asset Management fees. Salary and benefits for fund managers, their analysts and support staff are included here. Fees typically costs .5% to 1% or more.
- Marketing fees. Some mutual funds use what’s called the themarketingheaven.com to help defer direct marketing costs including advertising, brochures and ‘rebates’ to plan record-keepers. Fees here range from .25% to a maximum of 1%.
- Trading fees. This is perhaps the least transparent area of fee disclosure maybe because it varies on any given day and over any year. Within each mutual fund, the manager is constantly making decisions which securities to buy or sell. Each transaction creates a fee that is paid but does not show up on your mutual fund statement. In addition, every time a plan participant deposits or withdraw money or shifts money between mutual fund options, the fund manager must again enter the trading arena ringing up additional costs to the plan which is paid by the participants. According to the study, these trading fees can easily rack up another 1% in annually fees.
The whole system is rigged in a way to drive profits to plan sponsors and mutual fund companies. Often, the mutual fund companies split their fees with the plan administrators who then tell the employers that they’ll do all of the administrative work for ‘free’. Employers typically have little expertise in the inner workings of the system and little incentive to strive for plan efficiencies since the employees are paying the bulk of the costs.
What should you do with the information from this study?
First, don’t use it as an excuse to discontinue contributing to your 401-k plan. Many employers provide matching contributions for at least a portion of your contribution. Second, you can significantly reduce plan costs by using index mutual funds versus actively managed mutual funds. Index funds cut costs two ways. Because they simply track an index, you eliminate the high cost of hiring stock and bond pickers, analysts and expensive research. Index funds also typically only do a fraction of the trading of an actively managed mutual fund. The result is much lower costs. For example Vanguard S&P 500 Index Fund (VFINX) has an annual management fee of only 0.17% and turnover less than 5% of their stocks per year. Compare this to actively managed T. Rowe Price U.S. Large Cap Core Fund (TRULX) with an annual management fee of 1.15% and 74% stock turnover annually.
Second, use the new disclosure information (due with your 3rd quarter statement) to analyze your plan’s overall efficiency and contact your employer if you feel it’s too expensive. Once employers understand the true facts of plan costs, my bet is they’ll demand cost-cutting measures of plan sponsors. After all, their employees are their most valuable asset!
My thanks to our summer intern, Elizabeth DeBardeleben, for her assistance with research for this article.