New 401(k) fee info can boost retirement savings

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(MoneyWatch) In the next few months, many readers will be receiving new 401(k) plan fee disclosures. The information they provide could help you significantly boost your retirement savings, so don't ignore them or throw them in the trash; that could be the equivalent of throwing away hundreds, if not thousands, of dollars, year after year.

The most important numbers to look for in the paperwork you'll receive are the annual expense ratios for your plan's investment funds and the actual amounts that your account was charged in the past quarter for administrative and investment expenses. Let's take a look to see how you can use each of these numbers to add more money to your total retirement savings.

Expense ratios and actual charges

The annual expense ratio of a plan's investment funds is usually shown as a percentage, typically somewhere between 0.10 percent to 2 percent (expressed as a decimal, that's 0.001 to 0.02). You may also hear these numbers referred to as "basis points" by financial professionals; the above range would be expressed as 10 to 200 basis points. And while these numbers may look small, they can represent a lot of money.

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Competitive annual charges for domestic equity and bond mutual funds in 401(k) plans would be under 0.50 percent, and the smaller they are, the better. Some large 401(k) plans may be able to negotiate fees for index funds in the 0.10-20 percent range (If you participate in such a plan, consider yourself fortunate.) Competitive international funds typically have higher expenses, with expense charges ranging from 0.50 percent to 0.75 percent, although the charges for some of these index funds may come in below 0.50 percent.

I'd be concerned with annual expense charges well above 1 percent. Fees at this level will slow the growth of your savings. You may see funds with expenses between 0.50 percent and 1 percent; most likely it's appropriate to invest in such funds, but I'd rather see the expenses below 0.50 percent.

There are many 401(k) investment funds whose charges are much higher than these amounts. For example, according to the 401k Averages Book -- a survey of 68 401(k) providers conducted by 401ksource.com -- the average total annual plan cost for a 401(k) plan with 100 participants is 1.30 percent. There's a wide range, however, with the lowest cost equaling 0.36 percent and the highest cost equaling 1.71 percent. For plans with 1,000 participants, the average annual cost is 1.08 percent, with the lowest and highest costs ranging from 0.30 to 1.71 percent. In my opinion, annual charges of 1.5 percent or higher is highway robbery; fees at this level will take a big chunk out of your savings. Let me show you why I say this by translating these percentages into dollars.

Suppose you have $100,000 in savings in your 401(k) plan. Here's how much your account would be charged for various expense ratios for periods of one year and five years:

0.20 percent: $200 in one year, $1,000 over five years
0.50 percent: $500 in one year, $2,500 over five years
1.0 percent: $1,000 in one year, $5,000 over five years
1.5 percent: $1,500 in one year, $7,500 over five years
2.0 percent: $2,000 in one year, $10,000 over five years

As you can see, these small numbers really add up.

Now take a look at the actual amounts your account was charged for administrative and investment expenses in the past quarter. Multiply those figures by four to estimate the total amount of your charges over the course of one year. You can then use this figure to estimate how much money you could save if you invested in funds with lower expenses.

In the above example with $100,000 in 401(k) savings, suppose your annual expense ratio is 0.75 percent. This would translate to annual charges of $750, and quarterly charges of $187.50. If you could reduce your expense ratio from 0.75 percent to 0.50 percent, this would translate to annual savings of $250. Over five years, you'd boost your 401(k) savings by $1,250. And that doesn't count the compounding of investment earnings that would add more money to your savings.

What can you do?

First, it's important to take a look at exactly what funds your money is invested in. It could be that you're invested in actively managed funds with high expense charges, but maybe your plan has index funds with much lower expenses. As my fellow CBS MoneyWatch bloggers Allan Roth and Larry Swedroe have so frequently demonstrated, there's a very good chance you'll accumulate much more money over time by investing in index funds rather than in more actively managed funds, driving your expenses as low as possible, and periodically rebalancing to your desired asset allocation.

Some of you may not have investment funds in your 401(k) plan that have competitive fees. If that's the case, then you have to decide whether it's worth it to invest in your 401(k) plan. Certainly I'd invest enough money to maximize the match made by your employer, since company matches will overcome any disadvantages you'd experience due to high investment fees.

But it's a complex decision whether to contribute unmatched money to a plan with high investment expenses. One consideration to take into account is the period of time you expect to contribute to your employer's plan. For example, if you expect to terminate in the next year or two, you can "rescue" your money when you terminate and roll it over to a low-cost IRA. Similarly, many plans allow in-service distributions at age 59-1/2; at that time, you can withdraw your accounts from your 401(k) plan without penalty and roll them over. If you're close to that age, you might want to consider continuing to contribute.

In any case, don't use the expense levels in your plan as an excuse not to save for retirement. You'll be better off saving money instead of spending it. If you don't like the investment funds in your 401(k) plan, investigate other ways to save for retirement, either through a low-cost IRA or just an ordinary investment account.

You can also ask your employer to investigate lower-cost investment funds. It's been my experience that employers often respond to employee requests if they're expressed in a constructive manner. In fact, that was one objective of the U.S. Department of Labor when they issued the regulations on fee disclosures -- the agency wanted to put pressure on plan sponsors and service providers to offer more efficient investment funds.

Like most aspects of your retirement planning, taking a few minutes to pay attention to the details of your 401(k) investments can really pay off when you retire.

  • Steve Vernon On Twitter»

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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