I’m a big fan of 401(k) plans as a way to save for retirement regularly and automatically, tax-deferred. You can invest up to $17,000 in a 401(k) in 2012; up to $22,500 if you’re over 50. But until now, there's been a big problem with these plans — it’s been virtually impossible for the 72 million 401(k) participants to know how much they’re paying in fees, unlike mutual funds which are pretty transparent about their costs in prospectuses and statements. That flaw is about to end. Kind of.
Amazingly, many employees and employers actually believe workers pay no 401(k) fees.
An AARP study last year of 800 people with 401(k)s found that 71 percent didn’t think they paid any fees for their plans. And in a survey of 365 administrators of 401(k) plans by the U.S. Government Accountability Office, half of the employers said they didn’t know if employees were paying investment management fees or (mistakenly) thought the fees were waived.
The High Cost of 401(k) Fees
Truth is, not only do employees pay 401(k) fees that are subtly extracted from their contributions, the charges can be enormous and really cut into your returns.
According to a recent study by the public policy research group Demos, The Retirement Savings Drain: The Hidden & Excessive Costs of 401(k)s, fees drain about $155,000 from the average U.S. household’s 401(k) account over its lifetime.
(MORE: Are Americans Really Able to Manage Their 401(k) Plans?)
According to a Fortune article on 401(k) fees, the average investor is charged 0.83 percent of assets annually. Employees at small businesses often pay much more — up to 3 percent a year, Fortune says. That’s because their firms often buy plans from insurance brokers who get paid by commission.
So I’m glad that the U.S. government is finally requiring employers to disclose their 401(k) fees in annual reports to employees by Aug. 30. Unfortunately, the new rules don’t go far enough.
2 Main Types of 401(k) Fees
There are all sorts of 401(k) fees, but these are the big two:
Investment product fees These are the most extensive charges. They’re what you pay for the investments in your 401(k) account, including fund expenses, trading costs, and management and purchase fees.
Administration fee. This is the amount employers pay an investment firm for administering 401(k) plans.
(MORE: Big Changes Coming to 401(k)s in 2012)
Flaws in the Disclosure Rules
Here are the three flaws in the new 401(k) disclosure rules:
1. You won’t be told the fees for your particular 401(k) investments. The statement you receive won’t be personalized. Instead, it will list the fees for every investment option offered by the 401(k) plan, whether you chose it or not. You’ll be told the overall fees per $1,000 invested, but not the fees for the amount in your account.
2. The fees won’t necessarily be easy to find in your statement. CNNMoney notes that the government didn’t put a page limit on the statements, so the documents will likely continue to run between seven and 12 pages.
“Some providers will provide this disclosure on page one, but for others it might be on page nine,” Mike Alfred, chief executive and co-founder of the 401(k) research firm Brightscope, told Reuters’ Mark Miller.
3. You won’t be able to tell whether your fees are high, low or average. The statements will not show how your 401(k) fees compare with those of other plans.
How to Use the New 401(k) Statements
So how should you use the new disclosure statements?
Start by figuring out your own 401(k) costs. Do this by dividing your total fees by your total 401(k) balance. Say you have $100,000 invested in two 401(k) investments, for a total of $200,000 and you’re paying a 1 percent fee for both. That means you’re paying $2,000 a year in fees.
Next, you should go to Brightscope.com to compare your plan’s fees with the averages of other employers.
Then, if you find that your fees seem excessively high, complain to your employer and find out if it's possible to switch to similar, less expensive investments.
What you shouldn’t do is move your money out of your 401(k) investment into another choice merely because the alternative comes with lower fees. Fees shouldn’t be your primary motivator for choosing a 401(k) investment. You should be selecting 401(k) investments based on your risk tolerance, diversification needs and the past performance of the particular investments.
Miller notes that sometime after Nov. 15 you’ll start getting better 401(k) fee information — what he calls your “aha” moment. That’ll happen when employers send account statements showing what you actually paid in dollars and cents in the previous quarter.
Here’s hoping that “aha” moment won’t make you say "Ah, nuts!"