Do you know how much it costs you on an annual basis to simply participate in an employer-sponsored 401k plan?
If you’re savvy, you probably already know that the mutual funds you select within your 401k plan have expense ratios. That number shows how much out of every dollar invested you give to the mutual fund company to manage the fund.
On average actively managed mutual funds cost around 1% of invested assets (or $100 for every $10,000 invested).
But if you think that is the only fee being charged to you, prepare for a shock.
New 401k Fee Transparency Rules
On top of your normal expense ratios that a mutual fund will charge you, there are hidden administrative fees taken from your 401k account to help pay for the management of the 401k.
This is a hidden cost that not many individual investors think of, much less have the chance to look into. That’s because 401k plan administrators make it incredibly difficult to tell how much money they are charging the individual investor in the plan to simply participate.
This lack of transparency is about to change thanks to new rules from the Department of Labor.
What are the new 401 transparency rules?
The government estimates that 72 million individuals participate in employer-sponsored plans like 401ks.
Those plans hold about $3 trillion in assets. Currently there is no law that forces 401k plan administrators to provide plan participants with all of the information they need to make an informed investing decision. This information includes fee and expense information.
Additionally no law requires the administrators to provide the information, if they do provide it, in a clear, understandable format.
The new rules fix this problem by seeing the investment of the 401k plan’s assets as a fiduciary act.
You may have heard that finding a financial advisor that has a fiduciary duty is much better than one that does not.
Because fiduciary duty means, legally, the person acting on your behalf must act in your best interest and not their own.
For financial planners this means not putting you into shady assets that earn them high commissions; for 401k plans it means providing clear cost information to plan participants.
How bad could the damage be?
Some estimates put 401k administration fees as high as 3% on an annual basis.
If that is even remotely true for your plan then your portfolio has taken an enormous hit that, over time, will cost you thousands of dollars. (And imagine a subset of an industry silently getting a 3% cut of $3 trillion in assets. It’s a ton of money.)
Pundits can throw out estimates as to the costs of 401k plans, but individual investors don’t really know.
When you receive your quarterly or annual statement and you feel like your portfolio underperformed, there’s no way to know whether that was due to plan fees or from investment performance. That lack of knowledge is what the government is taking aim at.
You can’t encourage your employer to find a cheaper plan if you don’t know what various plan administrators are going to charge to run your 401k.
How much might these hidden fees cost the average investor?
If you invested $5,000 per year into your company 401k for 30 years and earned a 7% annual return and had no added administrative fees, your account would grow to $546,091.
The same investment with just a 1% administrative fee added on drops to $443,432.
That’s a difference of 19% or $102,659.
If you take it to the worst case scenario of 3% administration fees, the nest egg is dramatically impacted. At that point your account only grows to $296,891. That’s 46% less than the plan with no plan administration fees tacked on and 33% less than the plan with the 1% administration fee.
As you can see the damage to your portfolio over the full investment term can be catastrophic to your retirement.
What specific changes will I see from my 401k plan?
What might surprise is this rule was announced in October 2010 but didn’t fully come into enforcement until January 2012. This was to give your 401k plan administrators and your human resources department time to react to the changes.
Starting this year you should see the following changes:
Quarterly statements: You should be used to receiving quarterly performance statements from your 401k based on the investments you have selected. Plan administrators must now also include fee and expense information in these quarterly statements.
Upfront expense information: Your plan administrator is now required to disclose any fees and expenses you will incur from an administrative expenses standpoint including accounting, recording keeping, and legal expenses. You must also be made aware of what costs you will incur by taking specific actions.
Investment information: You will also see information made available to you regarding the investments in the plan that should be easier to understand. This includes having available a website to show those in the plan what the funds are all about. You’ll also see information about market benchmarks and be able to compare the different funds available.
The changes are coming. Take advantage of them.
The new rules that are being implemented are for your benefit. These will help you better understand your 401k plan, the funds that are part of it, and the fees that are costing you.
But this means you need to pay attention and make sure you understand your plan and use the new tools given to you.
I hate getting nickel and dimed to death. The fees charged for record keeping seems out of wack with the actual work. I was paying $24-40 a year for “record keeping”. This was separate from any mutual fund expenses.
I think people with an annuity-based 401k are about to get a big surprise….
Curious if in response annuity based investments will ALSO show you an average of what your monthly “pension” would be if they annuitized…that’s how I would handle it if I were them
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Brent Pittman says
This move could only be benifitual to the consumer. Let’s hope more transparency = more money for employee retirement.
Long-Term Retuirns says
Thanks for this post. The new regulations are a HUGE deal for all the reasons you outlined. Low expenses are the most important part of any long-term investing strategy. Difference between 0.1% and 3.0% annual expenses will matter far more than what specific funds or asset classes you choose or what economic conditions will be over your lifetime. I wish individual investors had better appreciation for how deadly these high expense investment choices are to their financial well-being. It’s not 3% of *investment profits* that they charge you; it’s 3% of *all your assets*. Absolutely inexcusable.