How much is your 401(k) costing you?

I don't want to dump on your boss. She/he/it gives you a job (assuming you still have one). Besides a paycheck, you also get some benefits. One perk might be a retirement plan such as a 401(k). Your boss doesn't have to do that; in fact, it would be easier on her/him/it if there were no plan, since such things cost money, take up time, and expose the company to lawsuits.

So I want to start by commending your company for sponsoring a plan.

That said, there's been a disturbing trend over the past several years: Companies are shifting more of the cost of the plan onto their employees, and not necessarily being up front about it. One of the brave souls exposing this practice is David Loeper, a certified investment management analyst and the author of Stop the 401(k) Rip-Off.

How did Loeper come to take up the rallying cry for 401(k) reform? Here's what he told me in an interview:

It was time to put our 401(k) plan up for bid and look for competing vendors, and I got the typical sales proposals. They would say things like, “Hey, we can save you all of your administration costs if you use our expensive funds. And you don't have to pay that, your employees do. We are going to hide the expenses from the employees so they don't see them, save the company a bunch of money, and people won't know they are getting ripped off. Isn't that a nice deal?”

Well, I got ticked off when I got those presentations because we don't want to rip off our employees. We are honest with them.

So I went through my last five years' worth of statements from our prior 401(k) vendor. There is a column that says “Expenses,” and for five years it has shown zero in that column. Four times a year I get a statement that says I am not paying any expenses. [But then I looked through] some stuff like the summary annual report, and I figured out that I was paying $1,500 a year. I thought, “This is nuts!” I was paying 130 basis points [1.3% a year] to be in index funds.

Loeper's experience isn't unique. A study by the Government Accounting Office [PDF] found that an increasing number of employers are making employees pay more. These additional fees can take a huge bite out of your retirement savings. According to the GAO, paying an additional 1% a year can reduce your nest egg by 17% after two decades.

How can you determine if your employer-sponsored plan is beleaguered by hidden fees and kickbacks? Take these four steps.

1. Look at the Expense Ratios of Your Mutual Funds.

The expense ratio is the percentage of your assets that are withdrawn by the mutual fund company to pay for management and administrative costs. It should be found on your plan's website or other information made available by your employer. Ideally, you shouldn't be paying more than 1.0%, unless it is an exceptional fund.

Keep in mind that the expense ratio listed on a fund-information website, such as Morningstar.com, may not necessarily be the expense ratio you're paying. Extra administrative costs may be added to the funds in your plan (which we'll discuss in the next step).

Finally, we should note that the expense ratio for any mutual fund — whether in your 401(k) or elsewhere — doesn't capture all the costs you're paying. The biggest missing expense is commissions the fund pays to buy and sell investments, which are disclosed in the “statement of additional information.”

As un-thrilling as it might be to read such a document, you can get a rough idea of how much your fund is paying in commissions by looking at its “turnover,” which tells how much of a fund is bought and sold over the course of a year. For example, a turnover of 80% means that 80% of the fund's investments have been sold (or “turned over”) in the past year. The higher the turnover, the more the fund pays in commissions. Ideally, look for funds with turnovers less than 50%. Not only will this reduce commissions, but many studies have found that low-turnover funds, as a group, outperform high-turnover funds.

Related reading: A few months ago, Neal Frankle provided a guest post here at GRS that described how to read a mutual fund prospectus.

2. Ask Your Human Resources Department

Next, you'll want to know how the administrative expenses of your plan are paid. Your employer might be picking up the total tab — or it might be withdrawn from each employee's account. This could be a fixed amount (e.g., $300 for each participant) or a percentage of assets.

If you trust that the folks in your HR department will give you reliable information, ask them how much the plan costs and who pays the bill. They should be able to find out that information, and provide some documented proof.

3. Look at Your Summary Annual Report

If you want to investigate the plan expenses yourself, request a copy of your plan's Summary Annual Report, Summary Plan Description, and/or Fee Arrangement — essentially, any plan documents your employer will give you. As you scan the documents, you'll learn all kinds of good stuff about your plan, and it might spell out explicitly whether you or your boss covers administrative costs.

If not, then you might have to do a little math. Let's look at the example Loeper provides in Stop the 401(k) Rip-Off, based on his own (former) 401(k) plan.

In his Summary Annual Report, under the “Basic Financial Statement” section, Loeper learned that there were $11,304 in additional expenses. By dividing that amount by the total value of plan assets ($1,341,870), he calculated that his plan has an additional 0.84% in fees. After adding that to the expense ratios of his funds, he discovered that he was paying 1.3% a year to be mostly in index-based investments. That's way too high.

4. Evaluate Your Investment Choices

Retirement plan providers don't just get money from you. They also receive money from mutual fund companies to include their funds in your 401(k). These so-called “revenue-sharing agreements” (a.k.a. bribes) might entice a plan provider to stock your 401(k) with funds that will make the most for them, not for you. The solution is to match your investment choices up against a relevant index. If your funds consistently underperform, then you know you have sub-par choices.

What You Can Do

If your employer-sponsored retirement plan is the pits, you have several options:

    • If you no longer work at the company, transfer the money to a low-cost IRA.
    • Many retirement plans offer a brokerage window, which allows employees to buy individual stocks, exchange-traded funds, and other mutual funds.
    • Some plans allow for in-service distributions, which allow employees to transfer money to an IRA while still working for the company.
  • Your company may have a benefits committee, or at least a group of folks who occasionally think about the retirement plan (typically, the human resources folks and perhaps the CFO). You can agitate for better investment options, a brokerage option, or even a completely different plan.

Stop the 401(k) Rip-Off has some great advice for how to rally your colleagues around the cause of a better plan. Over at The Motley Fool, we've created a sample letter to send your benefits director. After all, their retirement is on the line, too. They may need just a small nudge to improve the plan.

J.D.'s note: In 1995, we set up our employee retirement plan at the family box factory. For the first few years we used SmithBarney to manage our investments. Then we noticed they were killing us with fees, both obvious and hidden. We said good-bye to them and now managed the retirement accounts in-house using Vanguard funds. This isn't practical for every business, but we only have about ten employees, so it works. I guess what I'm saying is: Brokamp has some great points in this article.

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Kevin@OutOfYourRut
11 years ago

“…there’s been a disturbing trend over the past several years: Companies are shifting more of the cost of the plan onto their employees, and not necessarily being up front about it.” Isn’t this what 401k’s were set up to do? To eliminate defined benefit plans and to transfer investment performance risk from the employer to the employee? Small wonder the trend is continuing with admin expenses. However, let’s not throw the baby out with the bath water, you’re better off with a 401k than without, especially if a generous company match is part of the package. Though in many organizations… Read more »

ObliviousInvestor
ObliviousInvestor
11 years ago

Agreed. The importance of expenses cannot be overstated.

On a related note, a study done by Deloitte and the Investment Company Institute a few months back showed that the median administrative fees on employer-sponsored retirement accounts was 0.72% of assets (on top of what the funds already charge). Yuck!

Jessie
Jessie
11 years ago

This sounds interesting….

I wonder if Canadian Pension Plans (defined contribution & defined benefit) as well as RRSP’s have anything like this…

Snowy Heron
Snowy Heron
11 years ago

This article is so right! It is even worse if you happen to work for a bank and they have you invested in funds that they manage – typically their performance is sub par and the costs are quite high. I worked for banks for many years and even in the best years for the stock market, I did not see much progress for my investments. Unless you are confident that your previous employer’s 401k plan is low cost to you, you should really rollover your 401k plan into an IRA at a low cost mutual fund when you leave.… Read more »

tinyhands
tinyhands
11 years ago

In the 3 years that I have worked for my current employer, I have put $13k into my 401k. My employer contributed $9k. Even after $2k in market-related losses, that’s a 46% return on my investment. I think I’ll stick with the plan.

David
David
11 years ago

Since we’re talking about 401k fees, I have related question. I have options to invest in several different funds. Among them are 5 SSgA index funds (the only index fund options in the plan). The expenses listed in the plan material shows the expense rations to be very low. They range from 0% on the S&P 500 to 0.28% on the emerging markets. If you look at the SSgA funds at their website, the expense ratios are much higher, ranging from 0.18% to 1.26%. My question is this. Are the expenses a combination of the 401k listed expenses and the… Read more »

JerichoHill
JerichoHill
11 years ago

If I wasn’t a Fed I would absolutely be checking an employer’s plan for hidden expenses.

Robert Brokamp
Robert Brokamp
11 years ago

David asks: “Are the expenses a combination of the 401k listed expenses and the SSgA listed expenses or should I just consider the expenses in the 401k documents?” You’ll have to do some digging to find out whether all the expenses of your plan are captured by the expense ratios of the funds, or if other money is taken from your account. If you trust your HR people to know all the details of the plan, you can ask them. Otherwise, you’ll have to comb through the plan documents. However, I will say that it’s not impossible that you are… Read more »

ObliviousInvestor
ObliviousInvestor
11 years ago

David: I can think of two possibilities that could cause what you’re seeing (and I’m sure there are several more).

It’s possible that you’re looking at different share classes. Sometimes funds offer a lower-cost share class exclusively for employer-sponsored retirement plans. (The share class is often referred to as R-Shares.)

Second possibility: It could be that the fund management company is temporarily waiving a portion of its fees for the fund. The 401k statements may report only the net, after-waiver fees, while the website may report both the gross fees and net fees.

The Frugal New Yorker
The Frugal New Yorker
11 years ago

Fantastic article. I recently enrolled in my company’s 401K plan and selected an index fund, but I have received almost no information on the specifics of the plan or the fund. Given this article, I’m going to make a bigger effort to get that information!

Adam
Adam
11 years ago

I can’t think of any reason to use a 401(k) except the employer match. The management fees are insultingly high.

For example, my Vanguard S&P 500 index fund (VFINX) has an expense ratio of 0.18% while my comparable S&P 500 index fund through my 401(k) has an expense ratio of over 1%!

Needless to say, I put in the bare minimum to get the full employer match and that’s it. What a scam.

TX2STEP
TX2STEP
11 years ago

Should I just cancel my 401K and move it all to a roth IRA?

jessieimproved
jessieimproved
11 years ago

TX2STEP: Not if your employer matches any of your contributions! With the match, you’re still going to get a much better deal, regardless of the fees.

Tyler@feet2thfire
11 years ago

As an accountant I audit a number of benefit (401(k)) plans and the lack of transparency over the fees is jaw-dropping. Giving each employee a single, transparent number as to what their investments are costing them should be, in my opinion, the next great thrust of those who are who are responsible for the security of the plans (SEC, Department of Labor).

Brian
Brian
11 years ago

Great article! I love these finance articles. I have a question though. In the case the employer doesn’t offer matching and Roth IRA is maxed out, does it make sense to contribute to 401k funds with ER averaging 1%? Is it a better bet to buy ETFs @ your brokerage of choice?

Kevin@OutOfYourRut
11 years ago

One comment in regard to company match. Some companies require the match to be invested in company stock, which can be a problem if it’s really shakey. The performance of the company stock in my wifes plan has been dismal (worse thant the general market) and I’ve heard of that happening with quite a few other people at different companies. Companies encourage (and sometimes require) purchase of their stock thru their 401k plans, and you’re often anxious to “invest” in your own company, as though you’re investing in yourself. This is a bad idea on another front though. If you’re… Read more »

Sam
Sam
11 years ago

This is a huge problem and only going to get worse and the mind-set of pensions and company sponsored retirement shifts further to personal responsibility for retirement. As this shift occurs, personal responsibility will include more and more the fees associated with 401ks. One of the reasons I stay away from target funds and other funds of funds is that they often have two layers off fees. There are lots of benefits to 401ks, reduce taxes, much higher contribution amounts than an IRA but the fees are super sneaky. One of the reasons I have not rolled over my old… Read more »

Artist
Artist
11 years ago

[email protected]: I thought that practice was made illegal after the Enron debacle?

Carmen
Carmen
11 years ago

Anyone know if there are any kinds of ratings/scores about 401(k) companies based on the administrative fees?

Finn
Finn
11 years ago

So for 2,000 days (5yrs.) Mr. expert certified investment advisor consultant,David Loeper,paid 130 basis points per annum to be in index funds?

Tyler Karaszewski
Tyler Karaszewski
11 years ago

My entire 401k is in a single index fund (FUSEX) with an expense ratio of 0.10%, so I don’t think my 401k is costing me very much, especially considering the 50% employer match on the first $4000 contributed every year.

Do I have a particularly good 401k, or is there something I’m overlooking?

Theory
Theory
11 years ago

@21, Tyler:

I have this same holding through Fidelity, with the same expense ratio, but there is also a “management fee” of 0.07%. From what I can tell in the section, the effective expense ratio is the sum of these two, 0.17%. I wonder if this is the same across different employers.

Paul in cAshburn
Paul in cAshburn
11 years ago

@tinyhands #5: “In the 3 years that I have worked for my current employer, I have put $13k into my 401k. My employer contributed $9k. Even after $2k in market-related losses, that’s a 46% return on my investment. I think I’ll stick with the plan.” Assuming your 401k balance is around $20k, be sure to mentally reduce the balance in your account by your future expected tax rate. For example, if your 401k statement shows you have $20k in your account, and you expect to be taxed at the 15% federal and 5% state and 1% locality tax rate… YOU… Read more »

Kevin@OutOfYourRut
11 years ago

Paul (23)–That’s as cynical & provocative as it is true.

Steve
Steve
11 years ago

My wife had a 401k (through a temp agency) that wrapped each fund in an account with a 1.3% fee. That was on top of the fees of the underlying funds, which weren’t that great to begin with. It was so high that the money market fund account had an effective negative interest rate. Depending on how bad your 401(k) is, you might or might not be better off investing outside. There are definite and concrete benefits to tax deferred investing. I did some back-of-the-envelope calculations and to me, it was worth paying about 0.5% extra in fees. This was… Read more »

Budgie
Budgie
11 years ago

Thanks for this article. It was something I never even gave any thought to. My company uses a 401k plan through Prudential, and right after reading this article, I found my statement online. It looks like there are all sorts of fees, but the statement is so confusing it’s nearly impossible to find out how much it’s costing in dollars and cents. Somehow I believe that was intentional on Prudential’s part! At any rate, thanks for making me aware of this. Thankfully, I haven’t been contributing any more than the bare minimum to get the employer match. You can bet… Read more »

RB @ Richby30Retireby40
RB @ Richby30Retireby40
11 years ago

Not to nit pick, but the more important issue is to pick the right funds and be properly invested in the markets, be it equities or fixed income.

Definitely try and gravitate towards low cost Vanguard-type funds, or ETFs if possible. Remember to check at least once a month to make sure your investments jive with your goals.

Just sock away the maximum 15K+ in pre-tax allowed every year, and you’ll wake up 10-20 years from now and be amazed.

Rgds,

RB

Rich By 30 Retire By 40

Kevin@OutOfYourRut
11 years ago

Artist (18)–You may be right about that (companies not being allowed to require investment in their own stock) but employees are still encouraged to invest in company stock, and then the herd instinct kicks in.

Jeff
Jeff
11 years ago

Unless your company matches, saving for retirement in IRAs seem more straight forward. But as #5 says, if they’re matching 50%+ for every dollar you put in, it’s a no-brainer.

Sara
Sara
11 years ago

Thanks for the great article! I haven’t really changed my 401(k) elections since I started my job almost 4 years ago. As soon as I read this, I logged onto the web site for my 401(k) plan and checked the expense ratios of my funds. Fortunately, they are pretty low. The S&P index fund, for example, has an expense ratio of 0.10%, so it looks like I’m not getting cheated there. I checked my statements for administrative fees and couldn’t find any. I’m having a hard time finding the information on turnover, though, so I may have to do some… Read more »

Jay
Jay
11 years ago

401(k)s were set up strictly to prop up Wall Street and to fatten the wallets of money managers.

The government should give people the option to opt out of 401(k)s and contribute higher amounts to an IRA or a Roth IRA.

The match doesn’t help if it is company stock. Ask the employees of Enron and MCI.

Dallon
Dallon
11 years ago

I use Fidelity Brokerage Link through my financial advisor, which provides me with many more funds than my employer provides. I receive the company match just as if I used the company’s funds, but I get a larger choice of funds. How would these hidden fees affect my Brokerage Link account?

bex
bex
11 years ago

JD: could you talk more about how your family’s business does their 401k? I ask, because I’m a small business owner, and I don’t want to get shafted with high fees. I’ve seen a lot of 401k offers for small business, and I’d prefer to go straight through Vanguard… but they only seem to have a “Simple IRA” plan (max 3% match), but not a full 401k. The cheapest offer I saw for 401k’s was ShareBuilder’s offer for Costco members… Approximately $1000 set-up fee, and $1000 per year to administer a 10-person company… and the funds were decent index funds… Read more »

ObliviousInvestor
ObliviousInvestor
11 years ago
Ross
Ross
11 years ago

At the last firm I worked I discovered that Both the financial consultant and the brokerage were taking “asset based fees” quarterly, usually just after all the dividends were paid. This was on top of the management fees for each mutual fund… My last year there I was socking away 19% (every year I would add 1% with each new pay raise) but my employer only put in 5% of my 1st 10%. Anyway I calculated that that my employer’s annual contribution ended up just barely paying the “asset based fees”. When I left I rolled the cash from the… Read more »

bex
bex
11 years ago

@ObliviousInvestor: the solo 401k works only for one-person companies, or “shareholder employees.” So that plan technically only works if somebody owns 5% of the business…

I’m looking for the cheapest solution for normal, salaried employees… I think I’m stuck with the Simple IRA.

RB @ RichBy30RetireBy40
RB @ RichBy30RetireBy40
11 years ago

Jay – I would have to disagree about your conspiracy theory. The 401k is actually one of the only ways people making over 100K can contribute any money tax free to their retirement. IRAs have a ridiculously low income limit of around 80K. 1st year MBA students out of a Top 10 business school, and law students entering corporate law are making over 100K off the bat. I would vote for congress raising the IRA contribution salary limit to 500K. Rgds, RB Rich By 30 Retire By 40 Jay Says: July 29th, 2009 at 6:28 pm 401(k)s were set up… Read more »

Jason @ Redeeming Riches
Jason @ Redeeming Riches
11 years ago

If the government really wanted retirement to be up to us they should raise the IRA limits. $5k or $6k over 50 is ridiculously low.

Personally I don’t think many employers really even know how their 401k works or what kinds of fees they are paying. With the new lesislation set to come out that requires more fee disclosure I think there will be plenty of frustrated employers who will be seeking a switch like JD did.

ObliviousInvestor
ObliviousInvestor
11 years ago

Bex: My mistake. From your comment I had mistakenly assumed that you were a one-person business.

You’ll want to look into “defined contribution” plans on Vanguard’s institutional site. More info can be found here: https://institutional.vanguard.com/VGApp/iip/site/institutional/clientsolutions/dc

HollyP
HollyP
11 years ago

What are the options for those of us who are fortunate to earn incomes above the IRA limit?

Several of my coworkers and I asked for more expanded options for our 401k. We got them – and every one was worse than the original option.

The only thing that offsets the high cost of my 401k are the tax savings, and the fact that the before-tax contributions have kept me under the AMT threshold.

bex
bex
11 years ago

@ObliviousInvestor: interesting… It looks like more work than a Simple IRA, but might be worth it. Thanks!

Marie
Marie
11 years ago

Not only was my 401k le suck, but there was no customer service, no website, and they charged me a huge fee to roll it over when I was laid off. At least it was a private company, so they had no stock to force employees to buy.

Lakita
Lakita
11 years ago

Baker,

Mission accomplished! I went from “I would never!” to “I have to give this some more thought…” at least a meet for coffee type of deal.

Maybe I’ll have time to look into this before my upcoming trip to get some local insight on Puerto Rico!

Meg
Meg
11 years ago

Glad I am maxing out my Roth prior to contributing as much as I can to my (“promised matched” after broken salary increase agreement”) 401K. Thankful to be employed, but VERY glad to have found this & other insightful sites.

Mike Alfred
Mike Alfred
11 years ago

Not all of the fees can be determined from looking at the investment options. Not all of the factors that are important to overall plan quality are related to past performance. Participants should first check to see if their plan is rated at http://www.brightscope.com before they attempt any of the other suggestions offered in this article.

Sara
Sara
11 years ago

Thanks for the link, Mike! I checked my company’s 401(k) rating, and it’s in the 75th percentile in its peer group, and the top 15% for lowest fees. Not bad.

Unlock Your Dollar
Unlock Your Dollar
9 years ago

I am happy with my choices in my retirement plan, since I am able to choose some Vanguard Index funds. I can’t imagine what it would be like to have a 401(k) in an insurance product again.

MeganW
MeganW
9 years ago

When I opened my employer’s 401k packet, it only took moments before I threw it down in sheer horror. Only load-funds. Every expense ratio > 1.5%. The next day I walked to the CFO and CEO offices. I was told, at our size (26-employees) this isn’t uncommon. “Nobody ever LIKES their 401k.” Sounds like a cop-out to me, but I sure can’t call my CEO on it. I even tried rallying in the breakroom, but the response was lacking. Now I understand why, thanks to Mike @ 45 and BrightScope: Net Plan Assets – <$3000 Total Participants — 3 Average… Read more »

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