A financially savvy client of mine was surprised last week when I mentioned that her 401(k) plan was not free. “But I checked with my company,” she said. “I asked what the plan costs, and they said it’s a free employee benefit.”
On the surface this may appear true, but, in fact, 401(k) plans are not free. There are several associated costs which are contained in the typical 20-40-page Summary Plan Description you didn’t have time to read. You are not alone. These documents tend to be incredibly dense.
The truth is that an Individual Retirement Account (IRA) is often a less expensive way to build a retirement nest egg. But if you have a 401(k) plan that offers an employer match, don’t leave money on the table. Contribute, at least until you reach the full amount your employer will match.
So let me help you with a run-down of common 401(k) fees.
The Department of Labor clearly explains the three basic types of 401k fees:
1. Investment fees – 401(k) plans typically offer a selection of mutual funds. Each fund has an underlying fee called an expense ratio, reflecting the cost to operate the fund. It is you and not your employer who pays this fee. The same goes for…
2. Service fees – These cover expenses like setting up and terminating your plan.
3. Admin fees – These cover features like a customer service line and your ability to access your statements.
Of these three fees, the only one you may have some control over is the investment fee. Your plan likely offers several funds to choose from. What you want to find out is the expense ratio for each fund you hold in your plan. The higher the expense ratio, the less you are making on your contribution since the fees come out of your account.
So, what’s a fair fee? According to Investopedia, “A good, low expense ratio is generally considered to be around 0.5-0.75% for an actively manage portfolio, while an expense ratio greater than 1.5% is considered on the high side.”
When you add the additional service and administrative costs to the investment fees, you will find that your “free” 401(k) is actually not as cost effective as a traditional Individual Retirement Account (IRA) that you hold at a brokerage or bank.
So, here’s my advice.
Or, you can leave the research to us. Just bring us your plan documents. We’ll be happy to help you calculate your plan fees and give you guidance on setting up an IRA if it makes sense for you.