Saturday, October 22, 2016

The Hidden 401(k) Fee Trap: Administration Fees

My employer offers a 401(k) plan through Fidelity which offers different tiers of investment options. I can choose from a variety of actively and passively managed mutual funds, "target retirement" funds, as well as individual stocks if I choose. Most millennial investors hear the same story from the financial press about 401(k)'s: contribute up until your employer match. It is indeed good advice because it's never a good idea to leave free money on the table. After all, if you earn $50,000 in a year and contribute 5% to your 401(k) with a dollar for dollar employer match, you will have $5,000 in your 401(k) at year end instead of $2,500; nothing beats doubling your money without any additional work! However, I wanted to take some time to focus on something that many millennial investors may overlook but can be equally dangerous as passing up free money: hidden fees in the 401(k) plan.

The U.S. Department of Labor has published a good guide that examines the variety of fees and expenses within 401(k) plans. Remember, all fees and expenses reduce investment returns, and therefore the long-term returns your 401(k) may earn. The Dept. of Labor guide discusses a scenario where a 1% increase in fees reduces a retirement account balance by 28% at retirement...that's a huge hit! 

The hidden 401(k) fee trap that I mention in the post title refers to the fact that while many people are familiar with the fees and expenses charged by mutual funds (i.e. sales charges and management fees), your 401(k) plan administrator may actually charge a plan administration fee, among other fees. Generally these fees are charged at the plan level and some percentage may also get passed on to individual employees. This blog post will be the first in a series of posts discussing these different fees.

A plan administration fee may be taken directly from your investment returns (a silent killer!), or you may pay it yearly, sometimes as a flat fee deducted from your account at the end of the year. There are multiple arrangements, but this fee is levied to pay for administrative services such as accounting, records keeping, and possibly even for additional service and support that your employer may have contracted for. Some employers automatically enroll employees in financial advice/planning programs, or offer other services that you ultimately pay for. Since many large corporations have so many employees enrolled in 401(k)'s, the overall administration fee burden on employees may be smaller, and in turn, larger for employees who work for smaller businesses. 

In July 2012, the Dept. of Labor enacted a rule to ensure that plan administrators mail you a fee disclosure so you can see exactly what fees and expenses you may be subjected to while enrolled in your 401(k). Most investors likely just discard this notice, but you should pay special attention to it. You can also log into your 401(k) account, or request this information from your HR or Benefits Dept. where you work. 

What can you do? Some employers may allow you to opt out of additional services that are paid for by the administration fee, so you may be able to lessen your fee burden that way. As the Dept. of Labor says, "generally the more services provided, the higher the fees." You should question whether you really use or even need the extra services that are being offered. This is particularly relevant when you are charged a yearly fee that is deducted directly from your account balance and not paid out of plan assets, because you will see the fee deduction at the end of every year.

Why is this all important? Consider the following. If you have a $10,000 401(k) account balance and are charged a 1% yearly administration fee, that's $100 that is taken away and won't contribute to long-term compounded investment returns. Assuming your 401(k) balance never changes (it will as the market moves up and down and as you invest more during your career), that yearly $100 charge turns into $3,000 over a 30 year career! With a 7% annual return, that $3,000 alone would become $22,836 over a 30 year career. The silent killer indeed!

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