401K expenses are making headlines again now that a lawsuit filed in 2006 by ABB employees in Kansas City, Mo. regarding losses in their 401K plans is now in trial. If successful, the U.S. Department of Labor, which has recently approved new rules for fee disclosure, may go even further in insisting greater transparency for the 401K process.
This lawsuit is important to anyone with a company 401K. Matthew Hutcheson, an expert in 401Ks from Portland, says that 90% or more of 401K plans in the United States are paying approximately 3% to 3.5% in fees. These expenses drag down any upward performance of 401K investments, so the participant receives fewer dollars in return at retirement. An excess charge of just 1% over 20 years will diminish the final dollar retiree return by an astonishing 20%. Think of how much 2% or 3% in unneeded expenses would further diminish it.
For example, if a 35-year-old 401K participant invested $15,000 at a 10% return that grew tax-free until he or she was 60, the return after expenses is:
3% expenses: $81,411
2% expenses: $102,727
The retiree with lower expense (2%) receives $21,316.00 ($102,727 – 81,411) more to spend. Though the 1% difference in expenses seems so small at the beginning, it compounds in importance over time in terms of dollars returned to the employee. And imagine, this is only on an original $15,000 investment. The greater the initial outlay, the greater the difference would be. These dollars, lost to the retiree, go to the plan advisors and others.
But, this needn’t be the case for you.
Find out what you are paying for management of your 401K funds by calling the plan administrator. Though there are several fees — such as administrative, service and miscellaneous costs — expense ratio is the largest and most important. Compare it to the average cost of managed mutual funds and the traditional lower cost of unmanaged index funds. The average cost of a managed mutual fund is 1.20%. Index mutual funds, which are unmanaged, traditionally cost much less at 0.2% to 0.3% and perform better than managed mutual funds because their expenses are less. Only two out of 10 managed mutual funds beat their relevant index in any one year.
If you are in high expense funds and your company offers alternatives: take advantage. If not, there are two possibilities. If your company offers a self-directed option, the easier alternative is to switch into it and then select low cost funds for yourself. The other is to try to change the 401K plan of your active employer. Federal law requires employers to devise and mange their plan in the best interests of the employee. This means that if the employee sees a way in which the plan can benefit him or her more, the employer is obliged to listen. The most effective way to do this is in writing, preferably with a group of other employees so the letter can’t easily be ignored. Although it is time consuming and difficult, doing this now could prevent a lawsuit such as the one filed by the employees of ABB.