Avoiding steep IRA fees

If an adviser is taking high fees from your IRA contributions, you might want to consider a DIY method.

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By Walter Updegrave, Money Magazine senior editor

Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

NEW YORK (Money) -- Question: My adviser charges me between 5% and 6% of what I invest in the mutual funds for my IRA. He says this fee is extremely fair to me. But I previously had an IRA for which I paid only $20 a year. What is an acceptable fee for an IRA? --Teresa Nagengast, Deptford, New Jersey

Answer: The timing of your question is perfect for two reasons.

First, with retirement accounts beaten down by the market losses of the past year, now is an excellent time for people to consider rebuilding the value of their savings at least a bit by making a contribution of as much as $5,000 ($6,000 for anyone 50 or older) to a traditional IRA or Roth IRA.

The second reason is that it gives me the chance to remind people of an important investing issue that they may be overlooking because we're so fixated on the market's wild gyrations. I'm talking about fees.

Added expenses

It's always a good idea to keep investment costs down. After all, every dollar that goes to pay advisers, investment managers and transaction costs is one less buck that stays in your account. But keeping a tight rein on expenses is even more important today.

Why? Well, back in the go-go '80s and '90s when the stock market was churning out double-digit annualized gains, giving up an extra percentage point or more in expenses didn't seem like such a big deal. But with decent returns much harder to come by these days, holding onto more of your gains could mean the difference between retiring comfortably and scraping by.

I'll get to the impact of fees in a minute as well as advice on what you can do to keep them down, but first I want to clear up some of the confusion about what you're calling IRA fees.

The 5% to 6% of your IRA contribution that your adviser is charging you isn't an IRA fee per se. It's a sales commission for the funds you're buying, or what's known in fund lingo as a "load." This fee -- which typically ranges from 3% to 6% -- is designed to compensate the adviser for selling the fund (and, ideally, for also providing you with some advice about which of the many funds out there are appropriate for you.)

You can avoid this fee quite easily by investing in a "no load" fund, which is one you buy directly from the mutual fund firm. If you do that, however, you'll have to decide on your own which funds to buy. I don't think that's a big deal. You can get help choosing funds by consulting our Money 70 list of recommended funds. If you prefer getting help with this decision, however, one way or another you'll have to compensate an adviser for his time and expertise.

Whether you opt for a load or no-load fund, you will also incur annual investment management fees. These fees don't go to the person helping you pick the fund. Rather, they go to fund manager, or, to be more precise, the investment advisory firm that employs the fund manager to buy and sell securities for the fund.

The investment advisory fee, plus in many cases some marketing expenses, shows up in the fund's expense ratio, which you can find for any fund by plugging its name or ticker symbol into the Quote box at Morningstar.com. The expense ratio couches your fund's annual expenses as a percentage of assets and generally can range anywhere from 0.10% to more than 2%.

Finally, the $20 annual fee that you mention is basically an account administration or maintenance fee. Many fund companies will waive this fee once your account rises above a certain minimum amount. Some may also waive it if you accept account statements and the like via the Web rather than on paper or if you agree to have the money you invest in the fund automatically transferred from your checking account. In any case, this relatively small fixed charge becomes less meaningful as your account value builds over the years.

Lowering costs

When you're deciding how to invest your IRA money, though, the fees you want to focus on most are the biggies: the sales commission and ongoing annual costs as represented by the expense ratio. And rather than thinking of this decision in terms of what fee is "acceptable," I'd say it makes more sense to think of how you might boost your IRA account balance over the long term by considering different options for lowering your investing costs.

For example: Say you're working with an adviser who picks a mutual fund for your IRA that charges a 5.75% sales load and has an annual expense ratio of 1.5%, which is about average for a stock fund. And let's also assume that this fund earns 7% every year before expenses and that you plan to invest $5,000 a year for 20 years.

Since 5.75% of your five grand is going toward the sales load, you're actually putting $4,712.50 into the fund. If you invest that amount each year, you would have an IRA worth just over $173,000 after 20 years.

Not bad. But can you do better?

One way might be to buy a no-load fund and eliminate the 5.75% sales commission. You would then be investing the full $5,000. Assuming you put your five grand into a fund that earned the same 7% before annual expenses of 1.5%, you would end up with just under $184,000 after 20 years, or roughly $11,000 more.

But could you do better still?

Well, let's suppose that in addition to eliminating the sales load, you also identified a mutual fund with a much lower annual expense ratio, say, 0.5% a year. If you invested $5,000 annually in that fund and it also earned 7% a year before expenses, after 20 years your IRA would be worth just under $207,000 -- about $23,000 more than investing in the no-load fund with 1.5% annual expenses and $34,000 more than the load fund with 1.5% annual expense.

To fee or not to fee

Of course, it's one thing to produce a higher account balance in hypothetical examples. It's quite another to pull it off in real life. I think most people are perfectly capable of choosing mutual funds on their own. But if that sort of thing isn't for you, then it could be a mistake to get rid of the adviser. Whatever you gain by eliminating the sales commission, you might lose by choosing an inappropriate fund.

Similarly, there's no guarantee that replacing a fund that charges 1.5% a year in ongoing expenses with one that charges 0.5% will raise your return by a percentage point. But, all else equal, your odds of ending up with a superior return are higher if you (or your adviser) choose funds with low fees. The easiest way to reap the advantage of low fees is to invest in index funds like those that appear in the index fund section of the Money 70. You can also screen for low-cost funds with our Fund Screener.

Bottom line: If you qualify for a traditional IRA or a Roth IRA, consider funding one this year as a way to get your retirement accounts back on track. Then home in on funds with below-average fees. After all, if you're going to go to the trouble of opening and funding an IRA, you might as well get the biggest bang you can for your IRA buck. To top of page

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