What Your 401(k) Really Costs You

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How much does your 401(k) cost? It's a surprisingly difficult question to answer, but the amount you're charged for your tax-exempt retirement plan can make a huge difference in how much you'll have when it comes time to retire.

The problem is, navigating the web of fees exacted by an army of Wall Street intermediaries who administer your plan and its investments is currently an exercise in guesswork. Bits of your hard-earned cash are siphoned off to pay a long list of middle-men: plan administrators, bookkeepers, lawyers, compliance experts, and the investment advisors who manage the mutual funds you hold are just some of the folks who get paid in the process. But don't expect their cut to show up on your quarterly statement.

[See U.S. News's list of 100 Mutual Funds for the Long Term, and research funds using our new Best Funds site.]

Instead, the fees most investors see barely scratch the surface. Right now, the 50 million or so Americans who depend on 401(k)'s for their retirement must rely on glaringly incomplete measures like individual mutual fund expense ratios that cover only part of the expenses charged by their plans. A host of other costs are either unknowable, painted in broad strokes, or obscured by confusing language, experts say. As a result, most workers simply don't know how their 401(k) fees work. In an oft-cited survey from AARP, more than eight in 10 401(k) participants didn't know what kind of fees and expenses were associated with their plan.

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"The problem is, people simply don't understand what they're paying, and for what," says Olena Berg, a boardmember at the Pension Rights Center and former head of the Department of Labor's Employee Benefits Security Administration during the Clinton administration.

Unfortunately, that lack of knowledge can be very costly over time. For a sense of just how great a difference fees make, consider this example: You're an employee with 35 years to retirement who's managed to save $25,000 in your 401(k). If your returns average 7 percent a year and fees and expenses shave 0.5 percent off of you returns, you'll retire with $227,000 even if you don't contribute another dime to your account. But if fees rise to 1.5 percent, your account will grow to just $163,000, according to the Department of Labor. That's a 28 percent difference.

Luckily, understanding 401(k) costs could be getting easier, and the most sweeping change could come as soon as this week from Washington.

As part of the American Jobs and Closing Tax Loopholes Act of 2010, regulators are taking aim at the way fees are disclosed and how they're presented to both employers and workers. Included in the bill H.R. 4213 are some new provisions that get to the heart of the transparency issue. Specifically, the bill requires fees for investment options in retirement plans be expressed in dollars or as a percentage. It also requires 401(k) providers to break out fees in more comprehensive ways for plan sponsors. They'll need to disclose all fees assessed against the participant's account, and group those fees into three categories: plan administration and record keeping fees, investment management fees, and all other fees.

"Guaranteeing the disclosure of hidden 401(k) fees will give Americans a fighting chance to strengthen their retirement and increase our nation's future economic security," said Congressman George Miller, a democrat from California, who authored that legislation, in a press release.

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At the same time, old hands in the industry are getting ahead of the legislation with better fee tools of their own. Putnam Investments, which runs some $22.6 billion in defined-contribution plan assets, has taken the lead in building better ways to break out fees in plain English. The firm is launching new online tools for retirement plan sponsors that will break out fees paid to plan providers in ways that generally match the model proposed by the government. For 401(k) participants, Putnam will unveil new tools to outline fund expense ratios, transaction fees, and other information designed to show individual costs of their plans sometime in July.