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Sneaky 401(k) fees
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July 9, 1998: 11:29 a.m. ET
Fees charged on 401(k) plans can add up, reducing your retirement savings
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NEW YORK (CNNfn) - As fees charged by 401(k) plans continue to grow, workers are increasingly being forced by their employers to carry the extra load.
Five years ago, 54 percent of workers in 401(k) plans paid for investment management fees, according to the Profit Sharing Council of America. Now, 62 percent are picking up the tab. About 27 percent pay for record keeping costs, up from 20 percent.
Blame it on the surging U.S. stock market, said Paul Yakoboski, senior research associate at the Employee Benefit Research Institute.
"We've had this great bull market run," said Yakoboski. "When you're getting double digit returns, you're less likely to worry about the fees."
While the information of these fees is available, the growth of 401(k) plans has led to a flood of novice investors who are unaware of the costs, or are unwilling to ask about them.
The normal economies of scale -- where higher participation should spread out the costs, resulting in lower fees -- simply haven't kicked in.
The reverse, in fact, is true, with expenses for 401(k) plans climbing from $4 billion in 1987 to $30 billion in 1997, according to Lipper Analytical Services. Overall expense ratios rose to 1.25 percent last year from 1.15 in 1996.
The increasing fees have raised the concern of the U.S. Pension and Welfare Benefits Administration, a division of the Labor Department, which has been studying the higher fees while urging investors to take a more active approach in learning about expenses.
It may be difficult to believe fees of just over 1 percent could radically diminish the amount of money you'll have at retirement. Some quick arithmetic makes it clear.
Consider the case of an employee with 35 years until retirement and a current 401(k) balance of $25,000. If her returns over that period average 7 percent and the expense ratio of her plan averages 0.5 percent, she'll have $227,000 at retirement.
However, if those fees are 1.5 percent, the account balance will grow to only $163,000, a reduction of almost $65,000.
If the fee for a particular 401(k) plan investment choice is higher than others, that doesn't automatically mean it should be avoided. Sometimes, quality is a factor in determining the fee, so a higher fee could mean the fund has been more capably managed.
You'll need to look at a combination of fees and past performance for you to decide if you think the fund's returns will more than make up for the higher expenses.
Good fees, bad fees
Increased fees are not a sign of greed, said Chris Wloszczyna, a spokesman for the Investment Company Institute, the national association of the mutual fund industry.
Instead, explained Wloszczyna, it's merely a symptom of a growing investment environment where new funds are popping up all the time to meet increased demands.
"Typically, newer funds tend to have higher expenses. International fund expenses may be higher because of the increased costs of investing overseas, but older, larger funds often have lower expenses."
This creates an upward bias on the average which can be misleading, he said.
Learning about the fees charged by your 401(k) investment choices is not as difficult as it might initially seem. The U.S. Securities and Exchange Commission, in a nod to investors, requires mutual funds to clearly spell out all fees and expenses related to the fund in its prospectus.
However, not all employers are diligent about making sure the prospectuses get into the hands of their workers. If you are considering participation in a 401(k) plan, make sure your human resources department provides you with this material for each of your investment options.
If you are already investing in a plan, check with your account statement or annual report (Form 5500) to review your current fees and expenses.
Once you have this information in hand you can begin crunching some numbers.
There are basically three types of fees and expenses which you may be required to pay.
Plan administration fees are costs associated with the daily operation of your plan, the accounting and legal services needed to keep it going. Telephone and computerized services may also be part of these fees.
The person who pays the bill for this varies. It could be the employer or, indirectly, the worker who has the costs deducted from the returns on his investment.
The second type of expense, and the largest, are investment fees which pay the fund manager for doing such a wonderful -- or lousy -- job of managing your money.
The investment management fees are usually knocked off your returns even before you get your statement so you will only get a net result figure (minus the fees) without seeing what your pre-fees returns were.
The last type of expenses are the individual service fees. These are charged separately to the accounts of individuals who use a particular plan feature, such as borrowing against accumulated 401(k) money.
In addition to fees charged for administering the plans, there are a variety of other fees which could lower your investment returns, including sales charges for buying and selling shares and 12b-1 fees, paid to investment professionals for pushing the company's mutual funds.
Despite your increased knowledge of fees, you'll still be limited to the choices of investment your employer gives you. However, you'll have a clearer picture of the costs of your 401(k) plan and will be able to reduce the unseen effects of fees.
-- by staff writer Randall J. Schultz
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