Is Your 401k Stealing From You?
One of the most widely used investment accounts is the 401k retirement savings plan. Investors from CEO’s to grocery clerks pay into these accounts as a central part of their retirement strategy. A solid 401k account can be the difference between a satisfying retirement and one filled with financial struggle.
But there are widespread problems in 401k plans, so much so that even the White House is pushing against the hidden fees that are buried in the vast majority of plans.
So, what are these fees and how much damage can they actually do to your account?
There are plan administrator fees, fund management fees, load fees, contingent deferred sales load, redemption fees, and 12b-1 fees. They can add up and do some serious damage.
For the most part, you can’t do anything about administrator and 12b-1 fees but they are typically reasonable even in the worst offending plans, and sometimes the employer covers those expenses anyway.
What you do need to think about are the rest of the fees, which can outrageous.
Redemption fees are usually incurred when you buy an investment in your 401k and then sell it again within a short period of time. The best way to avoid these is to remember that you are investing for retirement and only buy into funds you feel comfortable holding in the account for at least a year.
The biggest problems in 401ks are load fees. These can be as high as 8.5%, but are usually in the 5% range. Regardless, a load fee is something you should never, ever pay if it can be avoided. The majority of that 5% is commission paid to the plan administrator for including the offending fund in your company’s 401k investment options.
The next biggest problem is the management fee, or expense ratio. In some funds, this can run as high as 3%. As a general rule of thumb, if the fund management fee is above 0.75% (or even 0.50%), try to find a less expensive option.
The best way to do that is usually to replace a mutual fund with an Exchange Traded Fund (or “ETF”) that gives you approximately the same exposure to the desired investment.
Let’s look at a specific example – the John Hancock Large Cap Equity Fund A Class shares (“TAGRX”) which are available in many John Hancock administered 401k plans. The front end load fee on this fund is 5%. So, this means that if you put $100,000 into this fund you immediately lose $5,000 to commissions paid to the administrator. The expense ratio of 1.06% is below average for a fund of this type, but still really high compared to alternatives that are probably also in your 401k options. If your investment stays level during the year, this is another $1,000 or so of your money lost to fees for a total approximate fee loss of $6,006 for the year. So the fund has to do at least over 6% for the year just to get you back to break even.
If your plan has John Hancock Funds, it probably also has John Hancock ETFs. The John Hancock Multifactor Large Cap ETF (“JHML”) is comparable to the TAGRX fund above, but has no sales load and an expense ratio of 0.35%. So, total approximate annual fees of $350 for a $100,000 investments vs. up to $6.006. Think about that.
Chances are you rebalance annually. If you are replacing one load fund with another each year, or even every other year, you are costing yourself huge amounts of money in retirement.
What does huge mean?
CASE STUDY: 401k Account – 53 Year Old Senior Executive at a National Food Company
Approximate 401k balance at time of analysis: ~$700,000.
Click graphic to enlarge
9/10 holdings had fees he didn’t know about. He had rebalanced each year for the previous 5 years and as a result was losing about $10,800 a year to unseen fees. Think about that – nearly $55,000 over 5 years lost to avoidable fees.
That’s expensive, but it doesn’t stop there.
Let’s say he stopped buying load funds with high expense ratios and replaces them with lower cost ETFs from here on out.
How much did he really lose from just 5 years of not understanding fees and investment choices in his plan?
1) He retires at 65.
2) His account averages 7% a year from this point forward.
A) Year 1 of retirement: $128k in missed gains lost to avoidable fees.
B) Year 10 of retirement: $254k in missed gains lost to avoidable fees.
What if he’d kept rebalancing into the same type funds each year until age 65?
A) Year 1 of retirement: $374k in missed gains lost to avoidable fees.
B) Year 10 of retirement: $736k in missed gains lost to avoidable fees.
This is widespread. Most companies, however well meaning, have these fees in their 401k plans. The bottom line is that the benefits coordinators aren’t investment advisors – they listen to what the plan salespeople tell them, pick the one with a recognizable brand or that they think they understand the least poorly, and move on to their next problem. Looking under the hood on investments isn’t in the job description or in their training.
If the senior executive above hadn’t decided to get his 401k independently evaluated, he probably would have missed out on around $500,000 or maybe more in retirement. That’s a BIG number and it’s why you need to look under the hood on your 401k and understand what’s happening.
If you can’t make sense of your choices or don’t have the time to dig into your plan, talk to someone that can.
These hidden and mostly avoidable fees could be the difference between having a vacation home in retirement or not, or a grandchild going to the college of their choice, or spending a year or two abroad.
It’s your money.
If your portfolio is $300,000 or more, click here to find out what you are paying in avoidable fees and get suggestions that can keep more of your money working for you. Just mention 401k fees in the message box.
As always, if you have questions about this update or just need a little guidance in the right direction, feel free to get in touch.
To Smarter Investing,
Chief Market Strategist
ACI Wealth Advisors, LLC.
Process Portfolios, LLC.
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