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Walter Hopgood, 32, has two simple
questions. First, why does his 401k plan charge him $13.50 a
share for the same mutual fund he could buy in the open market for
$10.50 a share? Second, why didn't anyone warn him about it?
"It's a total rip-off. Every
person in this company is losing money hand over fist," a
computer systems analyst at a Silicon Valley company.
He's asked the plan administrator
at his company and his human resources department, and even went
to the 401k plan recordkeeper. "They gave me a song and
dance. No one could really explain it," he said.
Even worse, he says, is that he
didn't know he was going to have to pay this much until his first
statement arrived in the mail.
Hopgood's case is extreme, but it's
not unusual for 401k plan participants to be in the dark about
the fees they pay for their plan's services. Sometimes it's
because they don't ask, and sometimes it's because the plan
administrator won't tell them.
The employer often picks up at
least some of the administrative costs. But in the majority of
cases the participant has to pay the investment-management costs.
There's no tried-and-true formula to say who pays how much and for
what. Like snowflakes, no two 401k plans are exactly alike, and
that includes the fees charged to participants. Concerned that
workers don't get enough information, the U.S. Department of Labor
currently is currently pushing plan administrators and plan
sponsors to disclose more about fees.
In the meantime, here's a look at
some of the basic fees, how they're calculated and what you might
want to ask your plan administrator.
The Impact Fees
Have On Your Account
In this age of 20% market returns,
it may seem silly to worry about a 1% fee. But, there's no
guarantee that the good times will last forever. When the market's
only growing 7%, a 1% fee can have a significant impact on your
bottom line.
The U.S. Department of Labor's
pamphlet "A Look At 401k Plan Fees for Employees"
provides an example.
Suppose you have 35 years until
retirement and a current 401k-account balance of $25,000. Let's
assume your average return is 7%, you don't contribute another
dime to the account, and the annual fees are 0.5%. In 35 years,
your account balance should grow to $227,000. If the fees were
just one percentage point higher, 1.5%, at the end of 35 years,
your account balance would be $163,000. That's a $64,000, or 28%,
difference.
What You're
Paying For
So the obvious question is, what do
these fees buy?
Retirement fund fees go to pay for
three general costs: administrative, investment and services.
- Administrative fees cover
the costs of maintaining a plan such as the recordkeeping,
accounting, legal and trustee services. They often include the
preparation and mailing of account statements and other
educational materials. The fees often cover the cost of running
Web sites, access to customer service reps, investment advice and
access to plan information, daily valuation, and on-line
transactions.
- Investment fees cover the
costs of managing the retirement plan investments. These fees go
to pay the fund manager and any clerical staff. The fees pay for
investment-related expenses such as brokerage commissions and
advertising.
Sales charges, known as loads, are
often included in investment fees. These charges may be paid up
front (known as a front-end load) or when the mutual fund shares
are sold (known as a back-end load or redemption fee).
- Special service fees often cover
such things as loans.
In Hopgood's case, the recordkeeper
said the extra $3 a share he paid for his investments covered the
company's administrative costs to operate in 50 states. His plan
also offers extras such as 14 investment choices, a book to
explain investing strategies and Internet and telephone access to
account balances and fund allocation.
If your 401k plan is managed by
an insurance company rather than a mutual fund company, you may
have to pay additional service fees known as "wrap"
fees. These service fees are common if a variable annuity contract
is offered. The annuity may also include an insurance element. The
entire package may offer the retired employee regular income
payments, interest and expense guarantees, and death benefits.
Insurance companies often tack on extra charges for insurance as
well as surrenders and transfers.
How Fees Are
Calculated
Most of the fees plan participants
deal with are calculated one of two ways: either as a percentage
of the assets held in the plan, or on a per-person basis.
Generally, administrative fees are
charged on a per-person basis. The reason is that often
administrative costs are the same for every participant. For
instance, the administrative overhead for a single plan
participant may be $150 a year, regardless of whether the
individual has $1,000 or $100,000 in the plan.
Investment fees, following the
practice on Wall Street, are charged based on the amount of assets
held in the plan. For example, a fund may charge a 1% investment
fee. That means a participant with a $1,000 investment in the fund
pays $10 annually, whereas someone with a $100,000 investment pays
$1,000 annually.
One point you should inquire
carefully about is whether administrative fees are included in
investment fees. This is a common practice, says Spencer Williams,
senior vice president with Mass Mutual.
Special service fees may be charged
on a per-person basis.
Guidelines
Given the variability of 401k
plans it's impossible to come up with a set of hard-and-fast rules
about fees and how to judge yours.
What's important is to know what
your money buys. If your plan has fees that seem on the high side,
but offers such benefits as free investment advice, Internet sites
and financial planning services, maybe you're not getting such a
bad deal.
That said, experts we spoke with
offered a few guideposts.
- In general, for a full-feature
401k plan, administrative fees run between $100 and $200 per
participant per year, Williams said.
- Most employers pick up the costs
of the administrative fees, said Trisha Brambley, president of
Resources for Retirement Plans Inc., a 401k plan consulting
company. "If the plan is big enough, it should pay for
the administrative fees," she said.
- Many mutual fund companies are
willing to waive sales charges, said Ted Benna, creator of the
first 401k plan.
- You should expect that total
expenses, investment or otherwise, should be 1% or less, Benna
said. "If they are significantly above that, you are
going to be hit pretty hard," he said.
If there's a 29% fee like Hopgood's, "you have to think
hard about if you want to be in the plan," Benna said.
- An important issue to consider
is whether you get a company matching contribution. That could
offset the impact of a pricey fee structure, Benna said.
"Even if fees are above average, you should still be
putting money in the plan. I would be encouraging someone to
drop out only if there is a really bad situation," he
added.
What You Should
Ask
John Fletcher, a retirement expert
with Century Business Systems, helps employers create 401k
plans. He often visits his clients to tell employees about their
plans, and his presentation usually includes answering questions
from the audience.
Many times he's hoping someone will
ask what this plan costs. Every single time, he's been
disappointed. "No one ever asks about fees," he said,
although they do sometimes ask whether it costs anything to switch
investment choices.
So before the employees can bolt
out of their seats, Fletcher explains the fee structure of the
plan.
Unfortunately, most plan
participants don't have someone like Fletcher as a resource. Many
employers don't employ consultants to educate their employees.
It's up to the employees to teach themselves.
Only about 15% of plan participants
understand how plan fees are charged, Williams said.
Here's a list of questions to arm
yourself with to ask your employer. Some of this information your
employer is required to give you by law.
- Ask for a copy of all the
prospectuses for the investment options offered in your plan.
The Securities and Exchange Commission requires all funds
registered with it to provide this document to investors, and
your employer is required to give it to you. The prospectus
should show the fees charged to customers.
A small percentage of plans offer non-registered investment
options such as privately managed funds or investments. These
are not required to have a prospectus, so if you have these
types of investment options in your plan your employer may not
be able to provide you with a prospectus. Still, it's a good
idea to ask your employer if it can provide some kind of
documentation about these investment options, because it may
contain information about fees.
- Ask for a copy of the summary
plan document for your 401k plan. Again, your employer is
required to give this to you. It may or may not spell out what
fees you are being charged and who pays for them. By the way,
you can also request a copy of the plan's annual report,
called a Form 5500, which the plan has to file with the IRS.
However, don't expect the 5500 to explain the fees you pay,
Benna said. "It's for the plan in aggregate. For the
individual it does nothing," he said.
- Who pays the plan administrative
fees?
- Who pays investment fees?
- Are administrative fees included
in the investment fees? How much are they? This may be a very
difficult answer to get, Benna says. "Some providers are
unwilling to disclose that information," he said.
Currently, this information is provided on a voluntary basis.
The Department of Labor is developing guidelines to report
these fees.
- How are the fees paid? Are they
charged to the plan or deducted from investment returns?
Where To Get More
Help
In addition to your plan
administrator and fund provider, the U.S. Department of Labor's
Employee Benefits Security Administration is a great resource.
It has produced a pamphlet titled "A Look At Plan 401k Plan
Fees … for Employees," and a similar one for employers.
It also publishes a 401k Plan Fee
Disclosure form that employers may voluntarily use to help explain
plan fees to employees.
Further, in April 1998, the EBSA
released a study of 401k plan fees and expenses. All these
pamphlets and the study can be found at the DOL Web site. (www.dol.gov/ebsa/)
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