Tim and Tom, twins from Tacoma, do many things in life exactly the same, including investing in their 401(k) retirement plan. But because of one difference – which moves into the national spotlight this month – they end up with significantly different balances to retire on.
Tim works for ABC Company. Tom works for XYZ Company. They each started contributing to their 401(k) plan in June 1982 when their employers first offered the accounts. They’ve always contributed the same $500 per month and their investment mix also includes the same weight of stocks and bonds.
Tim and Tom compare notes as they approach retirement and Tom is befuddled. He doesn’t understand how his account balance could have fallen behind by more than $50,000 – even though he contributed the same amount as Tim and invested over the same time period.
The mystery lies in expenses of the 401(k) plan. Until this month, Tom would have had very little ability to decipher exactly what the expenses were that created such a drag on his 401(k) performance. Thanks to long-awaited guidance from the Department of Labor that went into effect July 1, fee transparency is about to emerge on retirement plan statements.
Understanding the new details that clarify the various costs will be important. But more importantly, if you are a retirement plan participant you should consider what the costs mean in the context of your own investments and what are your options for change if you aren’t pleased with the costs of your plan?
This is your chance to inform yourself and understand how your retirement plan expenses compare to others. No longer will you have to contribute money to something without having any sense of what the costs are.
TYPES OF FEES
The individual investment choices within your plan have their own costs. The primary cost is the management fee or expense ratio charged by the mutual fund manager. The expense ratio differs depending on the type of mutual funds available and the class of shares used. Some share classes may include sales commissions or 12b-1 fees which are charged to cover distribution and marketing costs.
The investment management fees are built into the returns of the investments. This has historically made them tough to discern completely.
Administration of the retirement plan also creates expenses. Participants in the plan usually are charged for legal, accounting and recordkeeping services as well as for online access, customer service and tools or education to help make investment decisions. These costs have rarely been documented.
Some companies sponsoring retirement plans do pay administration fees without passing them through to the participant. But no company covers the management fees of the underlying investment options.
ISSUES TO CONSIDER
Your employer is obligated by the Employee Retirement Income Security Act (ERISA) to consider fees and expenses of your plan. The employer must act in the best interest of the plan participants when selecting investments and service providers.
If you have reason to believe that the fees charged by your employer’s plan are excessive, service is inadequate for the cost paid or the investment choices are poor, ask your employer to review the plan or even put the administration and investment selection out for bid from a new provider. Brightscope.com may be a good place to start evaluating the costs and quality of your company’s plan.
In some cases, your options are limited. The new fee transparency requirements apply only to defined benefit and defined contribution plans not to SEP and SIMPLE IRAs or other individual retirement arrangements offered by some small businesses.
ACTION TO TAKE
Regardless of the expenses in your retirement plan, if your company matches your contributions you should participate at the level required to receive the entire match. It’s free money.
If your investment choices within the plan are expensive and underperforming, you may want to consider not maximizing your annual contribution beyond the match. Depending on your income and eligibility, funding an IRA in addition to your employer plan would allow you to control your investment selection and costs. This is especially helpful if your 401(k) does not offer a diverse selection of investment choices to better manage risk.
Particularly if you are retired but still have money in the company plan, you should consider the benefits of a rollover to an IRA.
For some more expensive employer retirement plans, fees may be equal to what it would cost to hire a financial adviser who can not only provide investment advice, but help you answer all the other questions about your financial life that 401(k) administrators can’t help you with.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Read his blog at www.themoneyarchitects.com.