Employees will be armed with new information about the fees they're being charged in their 401(k)s in 2012. Beginning after May 31, 2012, 401(k) participants will receive quarterly statements showing the dollar amount of fees and expenses deducted from their account and a description of what each charge is for.
The fee disclosures are required by new Department of Labor rules and could provide shocking new information to 401(k) participants. A recent AARP survey found that 71 percent of 401(k) participants think they don't pay any 401(k) fees at all. "I think some people will be surprised about how much some of the investment options charge," says Mary Ellen Signorille, an employee benefits attorney for AARP. "Some plans charge each individual basically an account maintenance fee. The changes are perfectly legal, but some people may not have known they were being charged the fee." Among survey respondents who know how much they pay in fees, the most common fee range is between 1.1 percent and 5 percent of their account balance annually.
With this new information about the 401(k) fees you are paying, you will have an opportunity to reduce the costs of your retirement investments. Here's how to take advantage of the new 401(k) fee disclosures:
Switch to lower-cost investments. Use the new fee information to help select lower-cost investments that still meet your needs for growth. The savings could allow you to accumulate a dramatically bigger retirement account balance over the course of your career. A 30-year-old employee making $50,000 per year who saves 6 percent of annual pay, gets a 50 percent 401(k) match, and earns 3 percent annual pay raises would have $115,000 more in savings at retirement if his or her 401(k) plan had fees of 0.6 percent instead of 0.9 percent, assuming an 8 percent annual return, according to Aon Hewitt calculations. Dave Loeper, CEO of Wealthcare Capital Management and author of Stop the Retirement Rip-off: How to Avoid Hidden Fees and Keep More of Your Money, says you should aim for expenses of 0.5 percent or less per year.
[See 4 Hidden Costs of Investing.]
Boost your returns. Extremely high fees are generally associated with lower returns. A 2010 Morningstar study found that funds with low expense ratios consistently deliver higher returns than their more-expensive counterparts. Between 2005 and 2010, the cheapest domestic equity funds produced an annualized return of 3.35 percent, versus 2.02 percent for the most expensive funds in the same category. For taxable bonds, the cheapest funds produced a 5.11 percent annualized return, compared to 3.82 percent for pricey funds. "Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance," writes Russel Kinnel, Morningstar's director of mutual fund research, in the report. "Start by focusing on funds in the cheapest or two cheapest quintiles, and you'll be on the path to success."
Get the services you are paying for. In addition to disclosing the dollar amount of the fees deducted from your account, plan sponsors must also provide information about the services provided in exchange for each charge. If you find out that you are paying for services through your 401(k) plan, make sure that you take advantage of them. "If you are paying more than half of 1 percent a year, you should be getting some additional services like personal consultations about your particular goals," says Loeper.
Ask for better options. If all the investment options in your 401(k) plan charge high fees, consider asking your employer (nicely) to add some more affordable investment choices. It might be helpful to suggest similar funds with lower expense ratios, or that the 401(k) plan offer at least one passively managed index fund. "Inquire about why lower-cost options aren't available and if there might be something that could be added," says Loeper. "If you make an inquiry about whether it is possible to add this lower-cost index fund that is similar to what we've got, that might be enough to motivate your employer to get the problem solved."
Recruit help. At a time when layoffs are common, it's wise to not be the only employee criticizing the 401(k) plan. "Particularly in today's economy, you don't want to sound like a complainer," says Loeper. "If you are the only person that brings it up, your employer probably isn't going to act on it." It could be more effective to approach your employer with several other colleagues who also want to save money on their retirement investments.
New funds may be coming soon. The Department of Labor's rules were first published in 2010, and many companies have already begun looking for lower-cost investments and recordkeeping services in preparation for the required disclosures to employees. "A lot of 401(k) plans have renegotiated with their supplier and a lot of fees have come down somewhat," says Signorille.
Retire sooner. The expense ratios on your investments can affect how soon you are able to retire. A Towers Watson analysis of target-date funds, the most common default 401(k) investment, found that most target-date fund owners lose 30 percent or more of their potential retirement income to fees. That works out to be between five and 15 years' worth of retirement income that is deducted from a 401(k) account over a worker's lifetime.
Switching to investments with lower expense ratios could allow you to retire years earlier. Consider an employee with a starting salary of $45,000 who contributes 8 percent of his pay to a 401(k) each year between ages 25 and 62. If he invests his retirement savings in a target-date fund charging 1 percent annually, he will lose 13.9 years' worth of retirement income to fees, Towers Watson found. If he instead chooses a target-date fund charging 0.5 percent in annual fees, he will spend 7.7 years' worth of retirement income on fees. An even more affordable target-date fund charging 0.2 percent in fees would deplete his savings by just 3.2 years' worth of retirement income.