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This might come as a shock to you: Your 401(k) might not be the best place to keep your money.

I know, that sounds like crazy talk -- or at the very least, a rather contrarian observation. But bear with me.

I'll be the first one to admit that the 401(k) plan and its 403(b) and 457 cousins are fantastic vehicles for retirement savings. And you should be contributing to yours -- at least enough to get the full amount of your employer's match.

But after that, and when it comes to the balances you've left behind at past employers, it might be time for you to get acquainted with another good friend of mine: Mr. IRA.

Why? Because workplace savings plans can be expensive.

Wait. I don't pay any fees, do I?
You almost certainly do -- possibly as much as 1.5% of your holdings every year, maybe more. First and foremost, if your plan includes mutual funds, you're paying management fees and other expenses. Many popular retirement-plan stalwarts charge anywhere from 0.5% to north of 1% in annual fees. Index funds will have lower expense ratios, but even the stated amount doesn't always accurately reflect the total costs your plan is actually paying. For instance, those ratios don't capture all of the fund's actual expenses -- things like the commissions the fund pays on its trades are left out. Moreover, the fund company may be charging your plan for extra administrative costs.

But won't I pay most of that anyway if I hold the fund in an IRA?
Sure. But with an IRA, you could choose to hold some of those stocks or bonds directly instead, paying nothing but the cost of the trades. And it may be worth it to do so: 1% may not sound like much, but it makes a big difference in your results when it's compounded over many years.

How can I find out how much those other expenses are?
First, find someone in your HR or benefits department who knows the nuts and bolts of the plan, and ask them whether the plan's expenses are paid "at the plan level" (by your employer) or "at the participant level" (by you).

Second, ask for a copy of your plan's Summary Annual Report, Summary Plan Description, and/or Fee Arrangement -- whatever they'll give you. You'll probably find some record of the expenses charged to the plan (expressed as a dollar total), and if it's being charged to participants, you can divide that dollar total by the total value of the plan's assets to get a percentage. Don't be surprised if it's 0.50% or more, especially if you work for a smallish company. Yes, that's a lot.

Yuck. What can I do?
That depends on your specific situation, but here are some ideas:

Balances in former employers' plans are almost always better off in a rollover IRA at a discount brokerage. You can leave the money in mutual funds, move to better funds, or buy stocks or bonds or ETFs directly -- whatever you like. The transfer process is straightforward -- call the brokerage for friendly instructions.

For your current plan, consider these options:

  • Does your plan have index funds? They usually (but not always -- so check!) have lower expense ratios, and if your actively managed choices haven't been trouncing the indexes, the index funds are likely a better bet.
  • Does your plan have a "brokerage window" that allows you to buy stocks? If so, that may be a more cost-effective way to invest.
  • Does your plan allow for "in-service distributions" that would allow you to roll your vested balance into an IRA while you're still working there? If so, the IRA is probably a better bet.
  • If all else fails, find out if your company has a "benefits committee," or talk to that person you found in your human resources or benefits department and figure out how to argue your case for a better plan. Get a copy of the excellent Stop the 401(k) Rip-Off, for some solid advice about what to say and to whom. Then marshal your facts and let 'em have it (politely, of course!)

One last caveat: No matter how nasty your plan's fees are, don't stop contributing -- at least enough to collect the full amount of your employer's match. The match is free money: Don't leave it sitting there! It's easy to use outrage over the fees to talk yourself into spending your contributions instead. Avoid that trap -- your future retired self will thank you.

This article was originally written by John Rosevear on Dec. 17, 2008. It has been updated by Dan Caplinger, who doesn't own shares of the stocks mentioned in the article.

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