Is your 401k Plan a rip off ?
In recent years, participants in 401k plans have begun to expect more from their plans and their plan trustees. Plan fees are a significant issue. Some critics of 401k plans contend that excessive fees make 401k plans a giant rip off. Do you know how your plan stacks up?
Since 2012, the U.S. Department of Labor has required 401k plans to make an annual disclosure of plan expenses to participants. Most people don’t spend enough time with this important disclosure document. I encourage you to read yours and as you do, pay attention to two key areas: administration expenses and investment management fees.
Do you know who pays your plan’s administration costs? Plan administration includes necessary activities such as record keeping, tax filing, participant communications, etc. According to a recent survey by the accounting firm Deloitte, most 401k plans allocate administration costs among the plan participants. Only 25% of plan sponsors pay these expenses on behalf of plan participants.
If your plan allocates administration costs to participants, a simple calculation will help you estimate your share of the burden.
Ask your employer for a copy of your plan’s summary annual report. The report includes a table of financial data including fees. If you divide the fees by the plan’s ending balance, you will get fees expressed as a percentage of total assets. Multiply that number by your 401k balance to get an estimate of the dollar amount of administration costs you pay each year as a plan participant. The actual expenses you pay may be higher or lower depending on whether you receive any individual services like loans from your 401k account, but this estimate should be reasonably close.
The amount you pay for investment management depends on the specific funds you use. You can calculate your investment fees by multiplying the expense ratio for each fund by the amount of money you have invested in that fund. Expense ratios are part of the annual disclosure, but you can also look them up on websites like FINRA’s fund analyzer (https://tools.finra.org/fund_analyzer/).
For example, if you had $25,000 invested in the Dodge & Cox stock fund, you would multiply $25,000 by 0.52% to get $130—the amount it cost you to own Dodge & Cox stock fund in your 401k for a year. The total across all your holdings is the direct annual investment cost for your 401k plan. In today’s world, your total direct investment costs should be well below 1 percent of your invested balance.
As you read your fee disclosure, pay attention for something called revenue sharing. Under revenue sharing, the plan sponsor receives a portion of the investment management fees charged to the plan participants. These fees are often used to defray expenses that would otherwise be charged directly to plan participants or for plan-related services the sponsor would pay for separately. Usually, if there is revenue sharing, the expense ratios for the funds in the plan will be higher than without revenue sharing. For example, an index fund expense ratio should normally run between 0.10% and 0.20%. However, with revenue sharing the expense ratio for the same index fund could be as high as 0.50%.
Higher fees don’t necessarily mean your 401k plan is ripping you off. Some plans provide additional services like participant education and financial planning. These services usually entail additional costs, but they can make the plan much more effective for the participants. However, if your plan expenses are high but delivers bare-bones service, you may want to have a conversation with your plan’s trustees.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: firstname.lastname@example.org