If you Google “401(k) Fees” you may see the following headlines – Are Fees Draining your 401(k) Retirement Savings? – Hidden Charges Can Rob You of a Comfortable Retirement – The High Cost of 401(k) Fees – and the list goes on and on. While these are excellent questions and concerns, examining them out of context may do more harm than good. Instead of looking only at fees, a more reasonable approach would be to step back and 1) understand that specific services are necessary and must be paid for, 2) discover what total fees are being paid and how they are being paid, and 3) determine what value you are receiving for these expected and required services. Only after you have gone through these three steps would you have any basis for determining if your fees are reasonable.
Let’s start by acknowledging that some fees are necessary because services are necessary. Successful retirement plans need services ranging from compliance to investments. Compliance requirements are set forth in the Employee Retirement Income Security Act of 1974 (ERISA) and more recently the Pension Protection Act of 2006. These Acts set minimum standards for retirement plans in private industry. Investment services are necessary to assist in asset allocation decisions designed to achieve the investment objective of plan participants. By understanding that someone needs to get paid for providing this oversight, you have the opportunity to save for retirement in a tax efficient manner.
The second step is to determine what you are actually paying in fees, both direct and indirect costs. Direct costs are fees paid by writing a check. You may never see indirect costs because they are netted out of your investment return. A study conducted by AARP* revealed that 83% of 401(k) plan participants did not know how much they were paying in fees and expenses. The perception has been in some cases that there are no fees, that it is “no-cost.” This could not be further from the truth. Someone, somewhere, is getting paid somehow. The same study also discovered that 79% who make the decisions about their 401(k) investments said fees are an important consideration. If fees are that important, how can you rationalize your investment decision without knowing how much you are paying? To help uncover both direct and indirect costs, effective January 1, 2012, 401(k) plan vendors must start disclosing their fees to plan sponsors and plan sponsors must start disclosing fees to plan participants (see Doug Johnson’s article, 401(k) Plan Fee Disclosure Requirements by clicking here).
The third step is to determine if there is a fair ”balance” between fees you are paying and value you are receiving. Value can be viewed as both tangible and intangible. Tangible value may positively affect your investment performance while intangible value will benefit both the employer and employee.
How does tangible value affect your investment performance? It is easy to find many examples in the financial news on how a 1% difference in fees can have a dramatic affect on the value of your account at retirement. While that is very true in its most simplistic form, there is often no mention of the fact that the net performance of a particular investment with higher fees may be greater than an investment with lesser fees. As an example, if Fund A has a 2% investment fee but delivers a net return of 8% and Fund B has a 1% investment fee but delivers a net return of only 7%, Fund A has more “value.” If you were to make your investment choice based only on expenses, you would choose Fund B, overlooking the fact that other investments may offer the potential for a higher net return even with higher expenses.
And then there is the intangible side of value. Certain benefits should emanate from your retirement plan on which you cannot place a “dollar and cents” value. Some of these benefits should be:
- Your employees are educated on the simplicity of making appropriate investment choices
- Your service provider accepts responsibility to provide personal hassle-free, day-to-day support as an extension of your Human Resource Department
- Your employees are encouraged to participate through regularly scheduled meetings to keep them abreast of market conditions and aware of 401(k) topics of interest
- Your fiduciary responsibility is reduced because your 401(k) advisor monitors the 401(k) investment vendor who is providing fund choices for plan participants
After going through these three steps, you should realize that a successful 401(k) plan requires specialized services and fees necessary in order to obtain these services. Furthermore, if you have done your due diligence and uncovered all of the fees you are paying, you can now consider the original question of whether or not your fees are reasonable. Before you give a final answer to that question, maybe you should acknowledge that reasonable fees are not measured entirely in dollars and cents, but rather by the balance between fees paid and value received. If the fee side of the scale outweighs the value side, perhaps you should expect more from your service provider and increase the VALUE of your 401(k) plan. With this approach, everyone wins at retirement, even if it did “cost” a little more to get there!
Article Contributed By:
Boulay, Heutmaker, Zibell & Co. PLLP 7500 Flying Cloud Drive, Suite 800
Minneapolis, MN 55344 952.893.9320 | firstname.lastname@example.org
Boulay provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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