When you hold a fund over the long term, fees can add up significantly over your lifetime. Most target-date fund participants lose 30 percent or more of their potential retirement income to fees, according to a recent Towers Watson analysis of target-date funds. That works out to be between 5 and 15 years worth of retirement income that is deducted from 401(k) accounts over a worker’s lifetime. Passively managed and institutionally priced target-date funds generally had the lowest fees, while actively managed retail funds charged the most, the study found.
Consider a worker with a starting salary of $45,000 who saves 8 percent of his salary annually between ages 25 and 62. If he invests his savings in a target-date fund charging 1 percent annually he will lose 13.9 years worth of retirement income to fees, according to Towers Watson calculations. But if he chooses an ultra low cost target-date fund charging 0.2 percent in fees, he sacrifices just 3.2 years worth of retirement income to fees. A target-date fund with 0.5 percent annual fees would deplete his saving by 7.7 years worth of retirement income.
Target-date funds fees were found to have a bigger impact on a saver’s retirement income than the investment strategy of the target-date fund. Target-date funds differ in the percentage of the fund allocated to equities at various stages of a person’s lifetime, but most differences did not alter retirement income by more than two years, Towers Watson found. Target-date fund fees, however, eliminated between 7 and 12 years of worth of retirement income by charging between .5 percent and 1 percent fees annually over a participant’s career. In contrast, funds charging 0.2 percent in fees typically reduced retirement income by between 1 and 3 years. Workers who saved the highest percentage of their income for retirement often paid the most in fees.