Smart Choices Can Lower Your 401(k) fees

Some 401(k) plans—especially those at smaller companies—still stick participants with excessive fees. But employees are not powerless.

By making smart investment choices you can cut your costs. You first need to understand the fees your plan charges.

Plan-level expenses are charged by the plan administrator or custodian. These cover administrative services, such as recordkeeping, accounting, legal, and trustee services.

Fees on the underlying investments are charged by the mutual funds in your plan. Each fund charges an expense ratio, a portfolio management fee that is charged per dollar of assets in the fund.

Plan participants may also pay transaction costs for buying and selling funds. These may include trading fees and commissions that managers pay to buy and sell securities. Additionally, some funds also have sales charges or loads. These may be paid when you invest in a fund (front-end load) or when you sell shares (back-end load).

Choose Low-Cost Funds, Avoid Costly Extras

While there isn’t much you can do about the plan-level expenses, you can save money by choosing your funds wisely.

First, invest in low-cost funds.

Many actively managed stock funds have expense ratios north of 1% but rarely outperform the indexes consistently, so you’re unlikely to get value for your money. Most index funds charge a fraction of that. Switching to low-cost index funds where appropriate can greatly reduce annual costs and in the long run can produce a bigger nest egg.

There is an exception. While active funds that invest in large-cap US and foreign stocks aren’t worthwhile, they can be suitable in the small-cap, emerging-market, and specialty areas where an active manager can mitigate risk. But you should choose any active funds carefully and avoid those with excessive expense ratios.

Avoid funds with front-end or back-end loads if possible. Loads just suck up your money. They’re close to abusive.

Many custodians charge a flat fee for each mutual fund in your account. If your plan charges a $20 annual fee per mutual fund, for example, and you’re considering a $400 investment in a certain fund, it’s a bad move. That fee would drain 5% a year, at least to start.

Non-mutual fund investments within 401(k)s usually have high fees. Avoid variable annuities, which can have high, hard-to-understand fees.

What can you do if your plan doesn’t offer effective low-cost choices?

Some plans allow current employees to roll over assets to an IRA. It depends on the plan, so you must ask your plan administrator to find out if your plan allows in-service rollovers. If you switch employers, you can roll over your 401(k) funds to a lower-cost IRA with more investment options. And if you still have money in an old employer’s 401(k), it’s usually best to roll it over to an IRA.

If you’re not satisfied with your current plan, talk to human resources or the plan administrator. Asking for more fee disclosure and a greater variety of lower-cost investment options can alert your employer to wider dissatisfaction. Most employers want to do the right thing.

If you’re stuck with high fees, don’t use them as an excuse not to save for retirement. Saving in a tax-advantaged plan, despite the fees, is still exponentially better than not saving at all.

A good 401(k) plan should offer funds that provide broad diversification across each asset class, as well as on a total-portfolio level.

Even for smaller plans, there is no reason for fees to be out of control. While participant fees are part of the 401(k) package, understanding them and taking action can help you preserve a greater portion of your retirement savings.

David Walters, a financial planner and portfolio manager with Palisades Hudson’s Portland, OR, office, holds the CPA and Certified Financial Planner (CFP®) designations.

Palisades Hudson is a fee-only financial planning firm and investment adviser based in Scarsdale, NY, with $1.3 billion under management. It offers investment management, estate planning, insurance consulting, retirement planning, cross-border planning, business valuation and appraisal, family-office and business management, tax preparation and executive financial planning. Branch offices are in Atlanta, Fort Lauderdale, FL. and Portland, OR.

The firm’s recent book, Looking Ahead: Life, Family, Wealth and Business After 55, is a paperback and Kindle e-book available on Amazon at http://tinyurl.com/ocro2dx and at Barnes & Noble at http://tinyurl.com/m9ca3qk. Read Palisades Hudson’s daily column on personal finance, economics and other topics at http://palisadeshudson.com/current-commentary. Twitter: @palisadeshudson.