Your 401K or IRA may be charging you a lot more than you realize. A recent survey by retirement investment advisory firm Rebalance IRA finds that many full-time employed baby boomers do not have a clear understanding of the fees they are paying in their retirement accounts. In fact, 46 percent believed that they do not pay any fees at all and 19 percent suggest that their fees are less than 0.5 percent. Only 4 percent of those surveyed believe they pay over 2 percent in retirement account fees.
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“While some retirement accounts have lower than average fees, many have excessive fees that can cost individuals hundreds of thousands of dollars over the course of a lifetime!” warns Chris Carosa, a financial advisor and author of “Hey! What’s My Number? How To Improve The Odds You Will Retire In Comfort,” Carosa discussed the following important things most baby boomers don’t know about their retirement accounts that is costing them:
Boomer: What is the typical fee structure for a 401(k)? What about an IRA and a Roth?
Carosa: Each of these savings vehicles have a different fee structure and, within each, the fee structure is dependent on the size of the account and the services being provided.
In the case of a 401(k), you will typically be paying for a custodian, a recordkeeper (or third party administrator), a fiduciary advisor, and possibly an independent auditor and ERISA attorney. Among all these providers, you will find a variety of fee structures ranging from a base fee plus a per employee charge, a fee based on the assets held, hourly fees, and annual fees. Smaller plans that use “bundled” service providers often have a more difficult time seeing exactly how their fees are broken out because one company does everything.
In the case of an IRA and Roth, the fee structure will depend on whether the plan holds a mutual fund directly, buys mutual funds through brokers, or is large enough to be managed as a customized portfolio of individual stocks and bonds. If you hold a mutual fund directly, you often pay nothing in fees (remember, the operating expense of the mutual fund, commonly called the “expense ratio,” is not a fee for the purposes of the discussion here). If you buy funds through a broker (who may or may not be an advisor), you will normally pay a one-time commission and/or an ongoing 12b-1 or revenue sharing fee. These latter fees are what the president referred to as “backdoor” fees because the client often doesn’t see them unless they look really hard. Finally, customized portfolio costs depend on whether you manage them yourself (where you’ll only have to pay a commission and sometimes a custodial fee) or whether you hire a professional manager (where there is an additional service fee, the size of which depends on the size of your account).
Boomer: What are these fees for? Are you paying for people to shuffle paper around or do they have a valuable and useful purpose?
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Carosa: Each of the service providers mentioned above provide a vital function to the well-being of your account. In some cases, (e.g., the 401k plan independent audit), these services may be required by the government. In summary, the custodian holds the assets, the adviser manages the investments, and the broker makes the trades. These are your base services. For 401k plans, the ERISA attorney keeps the plan document in compliance with prevailing government regulations, the independent auditor ensures plan procedures are implemented in accordance to the plan document, the recordkeeper maintains the individual employee records, and the third party administrator runs annual tests to make sure the plan operates in compliance with various Department of Labor regulations.
Boomer: In monetary terms, how much do these fees add up to over the years in lost gains?
Carosa: This is a popular but unfortunately misunderstood question. It implies “low fees are always better than high fees.” Remember, when the Department of Labor came out with their 401k Fee Disclosure Rule a couple years back, they went out of their way to remind plan sponsors it’s not the size of the fee that matters, but the value of the services derived from that fee that matters. That’s an important distinction. It means some fees are good and some fees aren’t so good. The quickest way to understand this is with investment returns. Most people would accept a higher fee if that led to a chance for higher returns. On the other, they would question why they would pay more for the same return.
This, by the way, is the very question being considered by the Supreme Court right now – should a plan sponsor be held liable for failing to switch to a lower fee share class of the exact same mutual fund. That’s one of only two cases where you can specifically identify lost gains. The second example is with index funds following the same index. Here, there’s little reason to pay more for an S&P 500 index fund when the base return is identical.
That extra fee represents what you lose from that base return. And that “lost return” can add up over a lifetime of investing. The Department of Labor uses a case based on a 1% overcharge. The bad news: This can eat up about a third of your savings over the span of a typical working career. The good news: Rarely have I seen people being overcharged 1% (it’s usually no more than half that).
Boomer: How can you find out how much you’re paying? Where do you look?
Carosa: Employees can “see” what they’re paying by looking at the 401k participant statement. I say “see” because, although the Department of Labor requires plan sponsors to disclose all fees, the quality of that disclosure varies by service provider. For example, some employees think an “investment adviser” fee means they are getting individual investment advice, when, in reality, the fee is going to pay the plan’s adviser, not the employee’s personal adviser. For IRAs and Roths, the best way to find the fees is through the various service provider agreements you sign. Additionally, if you hire a Registered Investment Adviser, they are required to send you an invoice whenever they take fees out of your account, so at least you’ll have an easy-to-locate record. If you invest in mutual funds, whether through a 401k, an IRA, or a ROTH, go to page two on the prospectus.
There are two tables on that page, one for “Shareholder Fees” and one for “Operating Expenses.” Ideally, you’ll have no fees listed in the “Shareholder Fees” table and no “12b-1” fee listed in the “Operating Expense” table.
Boomer: Can you negotiate for a better deal on your fees? If so, who do you contact?
Carosa: This depends on the type of service provider and the type of plan, as well as your position within that plan. Only plan sponsors can negotiate fees for 401k plans, employees cannot. While it is often more difficult for plan sponsors to negotiate if their plan is small, they will often send out RFPs to get a better understanding of the range of fee/value of service options. Multiple RFPs can help facilitate negotiating no matter what the plan size. When buying mutual funds, as a practical matter it’s almost impossible to negotiate, no matter what your size. Individuals can, and often do, negotiate with other service providers. Speak to your service provider representative when negotiating. Again, size offers greater leverage in any negotiation. The bigger you are, the more likely they’ll listen. Conversely, the small they are, the more likely they’ll listen.