401(k) plans though have been among the least transparent investment vehicles and often believed to be a free service from your employer (they’re not). New rules aimed at making sure those costs are clear to you recently took effect.
What’s the big deal about 401(k) costs?
Plenty. While some employers cover the costs of a plan, most pass them along to the participants, and those transaction fees, administration fees, commissions, and the like can add up to a significant drag on your investment returns over time. Plan costs vary depending upon the type of investment, plan administrator, sales person, and even the size of the plan. The new rules require two types of disclosures; an annual notice with fund expenses and quarterly notices with actual fees paid.
If you have money in a 401(k), whether one you are currently participating in or a leftover from a previous job, you should have received your first annual notice from the plan prior to Aug. 30, 2012. “Easy to understand” unfortunately was not one of the requirements, so this document can be cumbersome. The annual notice provides information about investment choices within your plan, historical performance, and performance based against a benchmark, such as the S&P 500.
The notice will also provide fund expenses, or the costs associated with running each fund available. These will be expressed as a percentage and the actual dollar amount cost for every $1,000 invested.
You may notice that some funds cost more to run than others; international funds for instance are typically more costly than large cap index funds. The international fund may use an investment manager, while the index fund does not need management. Additionally, funds within plans run by insurance companies tend to have higher expenses than those in institutional investment companies like Schwab, Fidelity or Vanguard.
You won’t see these expense charges as subtractions on your 401(k) statements. They are taken out of the fund returns, so the effect is a reduction in performance. According to the U.S. Government Accountability Office, the average fund expense for larger plans (more than $10 million in assets) is 1.08 percent and 1.9 percent for smaller plans, although some funds can carry expense charges upward of 2 percent. Some may tack on an additional 1 percent for management or charge commissions.
Later this fall, you will receive your first quarterly statement. These statements will disclose the actual dollars paid for administration. You may see fees paid for legal and accounting services, administration fees for back office operations and online access, recordkeeping services or loan processing. Some fees that may not be disclosed are those that are paid out of revenue sharing through the expense charges (from the annual statement). So you may still not see all the expenses of your plan clearly, but it will be an improvement.
How does my plan compare?
That is still a question that remains. Seeing the fees disclosed in isolation does not give you a good picture of whether they are high, low or average. Certainly all plans must have costs associated, but some are clearly a better deal than others. That’s where a company called BrightScope comes in. On its website, www.brightscope.com, you can look up not only your plan, but others in your industry and see how your plan stacks up.
What about 403(b) plans?
The disclosure rules only apply to plans covered by ERISA, which does include some 403(b) plans. But that means that school district voluntary 403(b) plans are not covered, which is a shame because, in my experience, school district 403(b) plans are quite expensive compared to their 401(k) peers. Due to recordkeeping requirements, school districts typically have approved lists of vendors to choose from, and most come with high fees or annuity based products.
Locally, I have not yet seen a low cost option in the bunch. Most are designed to pay compensation to an adviser representative, through a commission or a percentage fee, which is fine if you will be using the services of the adviser, agree to that method of compensation and, most of all, are aware of the costs. But if you are a do-it-yourself investor or have your own independent advisor, you may be paying for a service you do not need. And you may not even realize that you are paying for the service.
Thankfully, the 403(b) Transparency Taskforce recently developed a 403(b) Model Disclosure Form to disclose fees and make comparisons among providers. If you are a teacher enrolled in a 403(b), be sure to get this form so you can make an informed decision. Also check out www.403bwise.com, a website that advocates for better plans and offers education on plan information.
What do I do now?
Use the information provided in your annual statement to make prudent investment decisions. Your decisions should not be completely driven by the expense charges, but they certainly factor into performance.
Should you stop investing if you don’t like what you find out about your plan? Not necessarily, especially with a 401(k) providing a match. The match should outweigh the extra expenses you are paying with your plan. For plans without a match, like a 403(b), the decision is trickier. In some cases, you may not be eligible to deduct an IRA contribution or contribute to a Roth, and your plan may be the only tax advantaged option for retirement savings. For an old 401(k) that isn’t up to snuff, you may want to roll the funds over to your own IRA, where you can control the costs and investment choices yourself.
If you find your current plan to be more costly than perhaps it could be, due to excessively high fund expense charges compared to similar funds in other plans, or higher than average administration fees or commissions, spread the word to your co-workers and talk to your employer. As a fiduciary of your plan, your employer should be working in your best interest, and may be persuaded to shop around for a better deal. Those fees directly affect your retirement success — and that of the employer if he participates as well — so it’s worth investigating.
If your 401k disclosure statement may as well be gibberish, give us a call and we’ll interpret it for you.