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Originally published October 12, 2013 at 9:04 PM | Page modified October 13, 2013 at 10:11 AM

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401(k) fees are eating up savings

As the conversation around fees continues to evolve, one conclusion is likely: All investors face them, and the best way to beat them may be to save more.

Special to The Seattle Times

A glossary of terms

401(k):  Employer-sponsored plan that allows employees to contribute money before taxes are taken out. Employers often match contributions. Interest, dividends and capital gains accumulate tax-free until withdrawn.

403(b):  Like a 401(k), but for employees of nonprofit and tax-exempt entities such as school systems.

Defined benefit:  Employer-funded pension plan that pays employees who retire a set amount based on a certain number of years worked. A traditional pension plan.

Defined contribution:  Pension plan in which employees and employers may contribute, with retirement payouts determined by how well the investment performs. A 401(k) or 403(b) plan.

IRA:  Individual Retirement Account. A personal retirement vehicle in which a person can make annual tax-deductible contributions.

Pension:  Payments by a company to an employee who retires, usually based on how much the employee earned and how long he or she worked at the company.

Roth IRA:  This variant of the traditional IRA has a few unique features. Where funds can’t be withdrawn from an IRA tax-free and without penalty until the holder is 59½, with the Roth IRA funds can be withdrawn tax- and penalty-free sooner, to pay for tuition or a first-time home purchase. The holder is not required to make withdrawals at any point. There is an income cutoff for eligibility.

Roth 401(k):  Employer-sponsored retirement account. Money goes into the account after taxes are paid and grows tax free. Employees of all income levels can contribute. Employers may match contributions.

Tax-deferred:   An investment such as a 401(k) plan or individual retirement account in which interest, dividends and capital gains are not taxed until the money is withdrawn.

Seattle Times research

Understanding your fees

Several financial-services companies and watchdog organizations have created tools to help consumers analyze 401(k) fees and future returns. If you want to tire-kick fees’ impact, consider the following:

Sharebuilder 401k Fee Fighters,

Brightscope ranks 401(k) ns at different companies.

FINRA fund analyzer:

Department of Labor Employee Benefits Security Administration explanation of fees’ impact:

Jane Hodges

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401k fees are just the beginning. Most people need to be a lot more educated about... MORE
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Roger Tan, a 32-year-old software developer at a Seattle startup, opened a 401(k) retirement savings account while working at Microsoft.

Like many employees who take advantage of this workplace benefit that allows for tax breaks and typically comes with their employer matching contributions, Tan made a habit of setting aside money from his paychecks to fund it.

And, like many 401(k) savers, he didn’t pay much attention to what kinds of administrative fees his plan shaved off his retirement nest egg.

“I’ve been pretty bad about reading documentation on my plan,” Tan said. “I’ve been historically more concerned with my funds’ contents. But fees are definitely something to consider now.”

To increase consumers’ financial literacy about their retirement savings, the Employee Benefits Security Administration last year instituted a rule requiring that all 401(k) plans provide an annual disclosure clearly outlining administrative fees to plan participants.

Previously advocacy groups argued that consumer ignorance about fees within 401(k) plans — fees that fund legal, administrative and marketing costs, among other expenses — means that many investors are saving less than they think.

More than 50 million Americans use employer-offered 401(k) plan to save for retirement, according to the Investment Company Institute. Because of their popularity as a savings tool, federal agencies and consumer-interest groups assert that better transparency around fees is vital to U.S. workers’ understanding of their future savings.

But now that such transparency is more readily available, what’s an investor to do? On the one hand, 401(k) plans with employer matching typically outweigh and compensate for administrative fees. But on the other hand, many investors may opt to ask an employer or its fund administrator to offer different, lower-cost funds or may decide to save elsewhere for retirement.

Do consumers understand?

Research varies widely on the extent to which consumers understand fees on their investments. Before the new disclosure rules, some 71 percent of 401(k) investors were unaware they even paid fees to a plan provider, according to AARP research. And, once alerted, more than 60 percent typically didn’t know what those fees were.

Conversely, research from the Investment Company Institute, which tracks the mutual-fund industry, indicates that savers are keenly aware of fees: Some 74 percent of investors review fees before making an investment, according to the institute.

Its research indicates that about 50 percent of all assets held in 401(k) plans are held in mutual-fund form. Equity mutual funds constitute a large proportion of those holdings, and 401(k) savers who choose such funds pay a 0.63 percent expense ratio on them, versus an equity-fund average of 1.4 percent.

Still, whether an investor is aware of fees or not, they can cut into a future nest egg. According to AARP, an investor putting $5,000 annually into a plan for 35 years at a 7 percent return with no administrative fees would park $469,000 for the future, whereas that same investor in a plan with 1.5 percent administrative fees would save only $345,000.

While better transparency and understanding of the mechanics of 401(k) planning are a good idea, some financial-services professionals say that the new disclosures aren’t necessarily that helpful. Kevin McCandlish, a wealth adviser at BMO Private Bank in Seattle, says that a byproduct of the fee conversation is that some consumers may use the knowledge of fees as an excuse to save less via their 401(k) plans.

“This concern over cost may keep consumers from participating in their 401(k) plans,” he says. “You shouldn’t let fees keep you from saving for retirement.”

Investors in 401(k)s concerned about fees need to pay attention to two measures on financial disclosures provided to them, according to the Employee Benefits Security Administration. These include total annual operating expenses, as well as “shareholder-type fees.”

Annual operating expenses may be displayed as a dollar amount or percentage charged annually per every $1,000 invested (say, $25 per $1,000 or 2.5 percent, or $1.50 per $1,000 or 0.15 percent). Shareholder-type fees outline costs for purchases or sales of funds which are applied directly to an account.

With a new awareness of fees in their 401(k) plans, some consumers aren’t sure what, if anything, can be done to lower them. Some types of assets will inherently incur higher fees, but their investment objectives and long-term performance may offset them.

Still, the Employee Benefits Security Administration and other organizations say that consumers concerned about high plan fees can ask their employer or plan administrator to seek out lower-fee vendors. The administrator can analyze fees on mutual funds and find other fund options that cost less — although careful attention will need to be made to differences in assets and strategies among funds.

Finally, consumers who have left a company where they had a 401(k) often have options to roll their money over into different retirement vehicles or to keep that 401(k) open.

McCandlish, the wealth adviser, cautions that fees are a significant but not the sole consideration in choosing funds and in choosing a vehicle for retirement savings — be it 401(k) or IRA. They’re more a conversation starter about where best to stow money, and how investment performance and fees combine to affect a portfolio.

“Fees themselves aren’t necessarily bad,” he says. “Fees for poor (fund) performance are bad.”

Tan, now alert to the specter of fees and how it may undercut his retirement savings, says he recently transitioned money out of his 401(k) into a rollover IRA. He said leaving his former job for a startup allows him to take advantage of an opportunity to roll over his Microsoft account into the outside IRA — an opportunity, he said, to rethink not only what funds he’s invested in but what fees he’s paying for the privilege.

While at Microsoft, Tan’s 401(k) plan pointed him toward a menu of about 20 Fidelity Investments’ mutual funds, so Tan read the funds’ prospectuses and invested in a mix of domestic, international, small-cap, and large-cap holdings that fit his strategy.

In his IRA, he plans to create a similar portfolio of holdings but do so using exchange-traded funds (ETFs), which typically have lower administration fees than mutual funds.

For other investors whose main retirement savings plan is housed within their employer’s 401(k), it may be worth investigating how the plan stacks up, double-checking whether it makes sense to move funds elsewhere, and possibly lobbying an employer’s plan administrator to re-evaluate a plan’s contents.

As the conversation around fees continues to evolve, one conclusion is likely: All investors face them, and the best way to beat them may be to save more.

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