Understanding Those Retirement Plan Fees
This is the first in a series of articles on retirement plan fees by Cherith Harrison, Founder Pin Money.
Wondering about the fees in your 401(k), 403(b) or IRA? Well, you are certainly not alone; there’s a big kerfuffle brewing about these fees. Why are there any fees at all? What are the fees for? Are these fees too high? Who benefits from the fees I pay?
As with any kerfuffle, there are a lot of misconceptions when it comes to these fees. I’d like to take this opportunity to separate the myths from reality because I believe it’s imperative that we all take advantage of these plans.
Why we need these plans.
First thing to keep in mind is that these plans, as established by law, are the best thing that has happened to the American worker since the word processor. You get to make pre-tax contributions, have your earnings compound tax-free while you are in the plan, and, in workplace plans, take advantage of any employer match. What’s more, because the traditional pension plan of yore is disappearing, and the future of social security is perennially uncertain (more on that in another post), these plans are your BFFs.
So how do the fees in these plans work?
There can be two types of fees: 1) investment management fees and 2) administrative fees. All so-called “workplace” plans – read 401(k), 403(b), 457, etc. – and individual plans such as the rollover IRA, Roth IRA, regular IRA, are structured around a menu of investments –think of them as the plan’s engine if you will. Most typically, the menu is a selection of mutual funds, so let’s stick with those costs for the moment.
Like anything in life of value, and like any other investment, these funds charge fees for their services. All mutual funds – whether inside or outside of a retirement plan – charge an annualized fee to their investors. This fee (known as the “expense ratio”) compensates the mutual fund company for its manger’s investment expertise, i.e. picking the stocks/bonds that go into the mutual fund, for administrative costs associated with the fund (think back-office stuff), and for certain other expenses outlined in the fund’s prospectus.
Expense ratios vary widely between funds; but here are some general rules to keep in mind:
- Bond-fund fees will be lower than stock-fund fees.
- Domestic-stock mutual fund fees typically are lower than international-stock mutual fund fees.
- “Actively managed funds”, where the fund manager is trying to beat an index like, say, the S&P 500, are more expensive than “passive” funds due to trading costs (among other things), like an S& 500 Index fund, where the fund manager is simply trying to track the index.
- Finally, who is the fund company managing the fund? Some companies are known to offer very low-cost mutual funds, while others are known to offer more expensive options.
- When evaluating your plan’s fees, consider:
- Focusing on only the funds you are invested in, or are considering, and not general plan rankings like you see in some third-party rating sites.
- You may actually be paying less for your investments in a workplace plan than you would on your own. Your employer will often have access to less expensive fund “share classes” (think along the lines of how many different fares various passengers pay on a typical airline flight) because of the size of the asset pool they bring to the fund manager – think all the employees in your company multiplied by all their contributions, plus your employer’s contribution, and you start to get the picture – this is good business for mutual fund companies.
How do I know what fees I’m paying?
You can easily find what fees you are paying for the various mutual funds in your workplace or individual retirement plan. Log on to your account, find a fund you are invested in, and now look for a link to the fund’s prospectus. By law, every mutual fund must have a prospectus in which all the fund’s rules and expenses are laid out in detail. The prospectus will show the expense ratio as a percentage – e.g. 1.0%, or 1.3% and also breaks out the various components of the expense ratio. (If you want to impress your friends, you can tell them the expense ratio in ‘beeps”. “Beeps” is shorthand for “basis points” – 100 basis points = 1%, 130 basis points = 1.3%.) You’ll also find a table in the expense section that reflects the “cost of ownership” of the fund in dollar terms.
Sometimes other costs associated with workplace plans can be offset by the expense ratio. These can include the costs of extensive plan recordkeeping/administration that is required by law, or the services of a “broker” or “financial advisor,” who may be retained to help educate employees. It just depends on the employer.
Visit pinmoneyclub.com to learn about a 1/1 evaluation of your retirement plan so you can get to the bottom line, faster.
Stay Tuned for My Next post: How do these fees get set, what’s a reasonable fee, and what can/should I do differently in my plan if I’m concerned about fees?
Cherith Harrison is the founder and principal of Pin Money Club which offers unbiased, personal financial training on a wide range of topics–from learning how to read and decipher your 401(k), 403(b) or IRA statement, managing and optimizing your credit score, to planning for elder care, to mastering the basics of investing. Services are offered in-person (where possible), or can be delivered remotely using a simple, secure, screen-sharing service. Visit pinmoneyclub.com for more information.