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Oct 12

401(k) Fee Disclosure Coming Soon . . .

by Anthony Farella

If you have a 401(k) account, your next statement may not look much different, but it will contain some very interesting and powerful information.  During the last several years, increased focus has been given to the expenses and fees charged to retirement plan participants.  The Department of Labor (DOL) recently published regulations under the Employee Retirement Income Security Act of 1974 (ERISA), as amended recently by Congress.  The new regulations require retirement plan sponsors to disclose the fees associated with your retirement plan including all 401(k) plans. 

The retirement savings landscape has changed dramatically over the last two decades.  In 1983, 88% of workers were covered by a defined benefit pension plan.  The 401(k) was a way for an employee to save additional funds for retirement in a tax-deferred account.  When an employee retired they could maintain their living standard through a combination of fixed benefit payments from a pension and Social Security.  Any additional savings were a bonus, but typically not required to fund daily living expenses. 

Today most employers have frozen or eliminated their defined benefit (DB) pension plans in favor of a defined contribution (401(k)) plan.  Defined benefit plans are very costly for employers to manage and contribution requirements can vary widely from year to year.  In a 401(k) plan, the employers’ costs are fixed from year to year making it easier to budget.  However, there is a major downside to moving from a defined benefit plan to a 401(k) plan as the primary retirement savings plan.  Now the risk of accumulating enough assets to fund retirement has shifted from the employer (DB plans) to the employee (401(k) plans), and many employees are ill prepared to manage this risk effectively. 

401(k) Plan Costs Vary Widely
All 401(k) plans are not created equally.  Typically, large employers have better plans that include bigger matching or profit sharing contributions, better investment fund line-ups and lower overall costs.

There are 3 components of cost to a 401(k) plan:

  1. Administration/record-keeping – A firm that keeps track of each employees’ contributions and balances.
  2. Investment options – The various mutual funds that are available in the plan.
  3. Investment advisor – A firm or person who gives participants advice, reports to the employer on performance and handles employee communication/enrollment.

Often, larger employers have the resources to deliver a quality 401(k) plan and their size usually drives costs down for the participants.  Small employers who do not have human resource departments or investment committees are often at the mercy of bundled product providers that include dramatically higher costs.  In the past these costs were skillfully hidden.  The new disclosure regulations were designed to shine a light on these deceptive practices and alert the individual participant to what they actually pay for services provided.

Why Costs Matter
Costs can vary widely among plans.  For instance, the Thrift Savings Plan (a 401(k) style plan for federal workers) has rock bottom costs of about .025% per year.  I’ve seen small private employer plans with costs that exceed 2.5% per year.  Private sector employees in high cost plans are paying anywhere from 10 – 100 times the fees that others pay.  The chart below illustrates the impact of high costs on the retirement lifestyle of a person working and saving for 40 years until retirement.

Annual fees as a share of assets in percent

Expected assets accumulated
(today’s dollars)

Reduction in
assets
accumulated (percent)

Expected annual income from savings (today’s dollars)

0.5%

$423,000

$28,113

1.0%

$377,000

-11%

$25,071

1.5%

$337,000

-20%

$22,411

2.0%

$302,000

-29%

$20,084

* Example saving $5,000/year for 40 years in a retirement plan account starting at age 25 and earning a real rate of 4%. 

** Expected annual income based on ability to annuitize the total accumulated savings at age 65.

The bottom line – you can expect to give up 11% to 29% of your retirement account to Wall Street for no additional value.  In addition, mutual funds that under-perform their benchmarks could further reduce the amount you accumulate.

At Rockbridge, we have been advising employers on their retirement plans since 1993.  Just as we do for all clients, we have a relentless focus on costs and seek to eliminate all fees that do not add value.  We welcome the changes in the 401(k) marketplace and will use it as an opportunity to educate employers on the value of full fee disclosure.  If you have a 401(k) account, please take a close look at your statement arriving this month.  We would be happy to review your holdings and fees and make suggestions on ways to reduce costs in your own 401(k) plan.

About the Author

Tony Farella, is a Certified Financial Planner® and a Principal Founder of Rockbridge Investment Management.  Tony is a contributor to Forbes, CNN Money, NAPFA’s FI Guide, Advisor Perspectives and local tv, radio and print publications.  Tony is the board director for NAPFA New England-Mid Atlantic Region), previous board member of the Financial Planning Association of CNY, acting Board Member of the Downtown Syracuse YMCA, as well as the Board of Directors for Countryside Credit Union.
Learn more and/or Contact Tony »


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