Perks can be ruined by high retirement plan fees
There’s a lot to like about employer-sponsored retirement plans like the 401(k): They’re convenient (funded via automatic payroll deduction), offer tax savings (contributions lower a participant’s taxable income, and investments grow tax-free) and many companies sweeten the deal by pitching in their own money to encourage employees to save.
But even this most valuable of company perks can be ruined by high retirement plan fees and crummy investment choices. It’s these factors that have more and more employees crying foul and filing lawsuits — more than a dozen in the past year, Bloomberg Bureau of National Affairs reported — against their bosses for the equivalent of 401(k) malpractice.
Potential awkwardness on annual Boss’s Day aside, the recent rash of worker uprisings over 401(k) fees is a good rallying cry for all investors to take a closer look at their workplace retirement plan.
The quality of a 401(k) comes down to the breadth of investment options, the management fees charged on those investments and the plan’s administrative costs. Unfortunately, if you work at a small company, the terms in your plan may not be the best.
A 2013 defined contribution/401(k) fee study by Deloitte on behalf of the Investment Company Institute found that all-in fees (including administrative, recordkeeping and investment fees) at small companies are nearly four times higher than those for larger plans. Companies with $1 million to less than $10 million in plan assets pay a median 1.27 percent compared to 0.37 percent for those with $500 million or more. In other words, $12.70, versus $3.70, of every $1,000 a worker invests is lost to 401(k) fees.
An employee’s 401(k) fee mileage depends on the investments chosen as well as fees the employee can and cannot control. Three key questions to ask when evaluating retirement accounts:
How plentiful are the investment options? According to research from the Investment Company Institute and BrightScope, the average 401(k) offers 25 investment choices. That’s more than enough as long as the menu of funds includes all the ingredients necessary to build a well-balanced retirement portfolio — a diversified mix of stocks, bonds and cash — at a reasonable price.
The best 401(k) plans offer an array of low-cost mutual funds that let investors cover as many bases as possible. Even then, some savers may find the choices too limited for their needs. In that case, an individual retirement account can be used to fill in the gaps.
What is the markup on the mutual funds in the plan? A plan offering plenty of funds, but only of the high-priced variety, is no better than a plan with limited offerings. A good rule of thumb is to steer clear of any fund with an expense ratio of 1 percent or more. And although index mutual funds are known for their low fees, beware of expense ratio markups there, too.
Go directly to the source for this information (via your plan’s 401(k) prospectus or the administrator’s website) since the expense ratio on a fund purchased in a 401(k) may be different from what’s posted on a fund company’s own website.
Who pays for housekeeping duties? Most companies outsource the logistical care and maintenance of administering a 401(k). And who picks up the tab? It might be you. It’s up to your boss to decide.
The plan’s fee arrangement details are disclosed in the 401(k) summary plan description or annual report. The most generous companies pay the entire bill. Others cover only a portion. The mark of a subpar plan is one that asks workers to foot the entire bill.
If you have a terrible plan
Even the worst high-fee, low-choice 401(k) is worthwhile — at least up to a point — if it includes an employer match on contributions. Never leave that money on the table. But for those workers stuck with a plan that lacks even that silver (dollar) lining:
Start with the DIY option: Direct your initial retirement savings dollars into a self-directed IRA and max it out before turning to the 401(k).
Look for an investing escape hatch: Some 401(k)s include a brokerage window — the option to open a self-directed account within the plan — which opens up the world of outside investment choices such as bonds, certificates of deposit, exchange-traded funds, other mutual funds and individual stocks.
Get out early via an in-service distribution: It works like an IRA rollover (only you don’t have to quit your job to do it) by allowing a current employee to move money from the 401(k) into a personal IRA without incurring early withdrawal penalties and taxes. Not all plans allow it, and often certain criteria must be met, such as being age 59½ or older.
Put on your activist cap: You can lobby for improved conditions for everyone. Talk to your human resources department, benefits committee or even the chief financial officer to push to include lower-fee investment options in the plan.