Few things in life are free -- including your 401(k).
There are many costs associated with your workplace retirement account, from the fees charged by your retirement plan's record-keeper to mutual fund expenses. And the amount you pay in 401(k) fees today can have a big impact on the size of your nest egg down the road.
Take a hypothetical employee with 35 years until retirement and $25,000 in his or her 401(k). If that employee didn't contribute another dime and had an account with average expenses of 0.5% a year, he or she would see that balance grow to $227,000 at retirement, assuming a 7% annual return, according to the U.S. Department of Labor (DOL).
But if those expenses were 1.5% per year, that same nest egg would only grow to $163,000. Just 1% more in expenses would reduce the employee's retirement savings by 28%. Of course, that's assuming a fund with the same 7% annual return.
While fees can take a big bite out of your retirement savings, many people simply don't know about them. A whopping seven out of 10 people surveyed by AARP in 2011 said they thought they didn't pay any fees at all for their 401(k).
"The money is being taken directly out of our accounts," said Christine Benz, director of personal finance at Morningstar. "It makes investors less sensitive to what they're paying."
Enter Uncle Sam. In 2012, the Department of Labor passed a rule requiring employers to provide 401(k) participants with annual 401(k) disclosures. That move aims to increase transparency and awareness around the fees investors are paying.
Expenses are far from the only thing you should consider when choosing a 401(k) investment. You need to consider your risk tolerance, a fund's performance and size, and timing. Nonetheless, fees remain an important factor.
Here are some things you need to know about 401(k) fee disclosure.
What will I see in my 401(k) fee disclosure statement?
Your disclosure statement will include two broad categories of information: plan-related information and investment-related information.
For plan-related information, you will find information regarding:
- Administrative fees: What you're paying for such things as record-keeping and legal and accounting services.
- Individual costs: An explanation of fees or expenses that might be charged to you based on actions you have taken, such as borrowing from your retirement plan.
- General plan information: An explanation of the structure and mechanics of the plan, including a list of the plan's investment options and details on how to direct investments.
Meanwhile, the investment-related information will include:
- Performance and benchmarking data: If a fund offered by the 401(k) doesn't have a fixed rate of return, the disclosure statement will show its historical performance over one, five, and 10 years. You'll also see data that compares the fund's returns with the returns of comparable indexes. If a fund has a fixed or stated rate of return, you'll see the annual rate of return and the term of the investment
- Investment-related information: Fee and expense information about each investment option in your plan. This will be expressed both as a percentage of assets and as a dollar amount for each $1,000 invested.
- Glossary and Web address: A definition of important terms found throughout the document, as well as a Web address where you can find more information.
How do I best use this statement?
While all of the information in your 401(k) fee disclosure statement is important, pay particular attention to the investment-related section. Why? The fees you pay for your 401(k) investments can account for as much as 80% of the total cost of your plan.
Another reason: Investment choice is the area over which you have the most control. You may not be able to urge your employer to lower administrative costs, but you have the power to choose among the menu of investment options in your plan.
Using this information, you can search for lower cost funds that match your investment goals -- or contact your employer if you aren't seeing enough low cost funds on the menu.
The total annual operating expenses of each fund in your plan that doesn't have a fixed rate of return will be expressed as both a percentage of assets and as a dollar amount for each $1,000 invested.
You can use this information to calculate how much you're paying in expenses each year for a fund you own. For example, a fund might have an expense ratio of 0.15%, or $1.50, for each $1,000 invested. That means if you invested $10,000 in this fund it would cost you $15.00 a year.
"Fund fees are the best predictor of whether a fund is a good or a bad performer," Benz said. "The good news is, increasingly, plans are embracing low-cost options."
Why are some critics unhappy with the 401(k) fee disclosure rule?
While mandated 401(k) fee disclosure offers retirement savers a spotlight on the fees they're paying, some say there's room for improvement.
In some cases, these disclosure statements are long -- 10 pages and up -- and might be written in language that is less than reader-friendly.
"It has tons of jargon," said Laurie Rowley, president of the National Association of Retirement Plan Participants. "It hasn't been as helpful a tool as it could have been."
Because there is no uniform requirement for how the information must be presented, fee disclosure statements can look very different from one company to the next.
"Reports can come in a variety of formats with varying degrees of granularity which make it very hard for the consumer to digest and understand," Herman said.
What should you do?
Even if your 401(k) fee disclosure statement is hard to navigate, it's worth taking the time to read it. If you're having trouble understanding it, seek help from your employer or from a financial advisor.
"Dig in," Rowley said. You wouldn't want to delay your retirement "just because you didn't check on what your fees were."
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