The Secret Cost of Your 401(k)

Need another reason to transfer that old 401(k) balance into a rollover IRA? Here's a good one: You're probably paying fees you don't know about.

Fees paid to your 401(k)'s providers can easily total 1% or more of your portfolio balance every year. That may not sound like much, but over time, it's enough to put a big dent in your investment performance. But survey after survey, including a big AARP study released this year, shows that the majority of participants in 401(k) plans -- 71%, per the AARP -- aren't aware they're paying for the privilege.

That's not a good thing.

Some fees are (sort of) obvious...
Some of these fees are familiar to most reasonably aware investors -- or at least they should be. In most 401(k) plans, most or all of the investment options are mutual funds. By now, most of us (I hope) know that mutual funds have a variety of fees, intended to pay the fund's manager and cover the costs of things like the fund's trading commissions.

These can range from the very low costs of an index fund, to the much larger expenses of an actively managed stock fund, particularly one with significant international exposure, which increases research and trading costs. Compare the expense ratio on the lowest-cost version of the popular Vanguard 500 Index Fund (a microscopic 0.06%) with that on an active international fund like Fidelity International Capital Appreciation Fund (1.09%, and that's cheap compared with its peer-group average around 1.4%) to see what I mean.

Those fees are part and parcel of mutual fund investing anywhere, of course. The good news is that 401(k) plan sponsors typically have lower-cost versions of popular funds available to them, meaning that you'll pay less in your 401(k) than you would if you walked in to a Fidelity or Vanguard investor center off the street. And thankfully, most 401(k) plan sponsors are clueful enough nowadays to pay close attention to fund fees and expenses and make sure that they're getting the best deal possible for their participants.

... but others are (almost) hidden
But the fees charged by the mutual funds are only one part of the fees you might be charged by your plan. Your employer -- actually, legally speaking, the plan itself -- may also be paying fees to the company that administers the plan on their behalf, and these fees may be passed on to participants.

What kinds of fees are these? They cover recordkeeping services, "custodial" services (Wall Street-speak for holding the money and securities), processing for all those 401(k) loans, shareholder services (including things like the folks who answer the phones), etc., etc.

These fees are disclosed in the plan's Form 5500, a little-known annual regulatory filing that lays out all the details of a plan's operations. I took a look at a few this morning, and while the fees aren't enormous, they're not zero:

Source: Brightscope. All data is from 2009, the most recent year available.

While smaller employers may have somewhat higher per-participant fees, most of the big-company plans I looked at are in the same general range as these, with a few exceptions. Again, these aren't huge numbers on a per-participant basis, but as we all know, fees on top of fees can make a big dent in your overall performance over time.

What you can do
Realistically, there's not a whole lot you can do about the fees in your current employer's plan, aside from taking individual funds' fees into account when choosing your investment options. But where these fees do suggest some action on your part is with any balances you may have in former employers' plans.

Think about it: When you add up the fees charged by the mutual funds in the plan, the administrative fees charged by the plan itself, and the gap in performance between most mutual funds and the portfolio of great stocks you can assemble on your own with a little effort, leaving your money in an old plan turns out to be an expensive choice, particularly when you compound that lost money over time.

Do you have money sitting in an old employer's plan? If so, take some time today to start the process of rolling it into an IRA at a discount broker. It's simple to do, it's usually free, and your future self will thank you profusely.

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