Since it was introduced in the early 1980’s, the employer-sponsored 401(k) plan has become one of the most common ways to save for retirement. Money comes directly out of your paycheck before taxes, the employer puts money into your account, and at retirement, you theoretically have a large pool of money that will support you until you’re dying day. But the pool could be larger.
The Department of Labor (DOL) requires all 401(k) plans to provide participants with information about the fees associated with the plan because even small fees can significantly reduce the amount of money you end up with.
A new report from the Government Accounting Office (GAO) says 40% of the 87 million workers who have access to a 401(k) plan don’t understand the fee information, 45% are not able to use the information given in disclosures to determine how much their investment fee is, and 41% don’t even know they pay fees.
There are two kinds of fees in a 401(k) plan—administrative and investment. There’s not much you can do about administrative fees. Only the employer can negotiate those costs, or lower them by switching to another plan administrator that has lower fees. You do have some control over the investment fees by the choices you make within the plan.
Generally, there are three types of funds in a 401(k):
- Target date funds, which are actively managed to optimize asset growth with a specific time frame in mind, for example 2030, 2040, etc. Target date funds often have high fees.
- Actively managed mutual funds, which can also charge high management fees.
- Index funds, which are invested to mirror the performance of different benchmarks, such as the S&P 500, the Russell 2000, or the EAFE. Index funds often outperform their actively managed counterparts with significantly lower fees.
Alhambra Investments CEO Joe Calhoun says, “Investors need to concentrate on what they can control and cost is an obvious one. Index funds are going to generally be cheaper than actively managed funds and even if the difference is small, compounded over a long period of time it can make a big difference in your retirement. The idea that you’ll make up the difference in cost by choosing a fund that outperforms the index is one that persists despite all evidence to the contrary. Active funds generally underperform index funds and cost more.”
The old days of “set it and forget it” in a 401(k) plan are gone. To maximize the amount of money you have at retirement, you must take an active role in choosing the investment options best suited for your goals and your wallet.