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Are you 401(k)o’ed?

Are you depositing money each paycheck to your 401(k) account? Up to the match or even beyond that? Each year, I deposit as much as I can, because even after the match, my plan’s S&P fund charges .05%. Let me spell that out, on $100,000, 1% would be $1000, .05% is $50. The account itself also has an $80 per year fee, so on that same $100,000, the total cost is about .13%. My balance is higher than this, so my cost is lower as an overall percentage.

Recently, I became aware of the 12th edition of the 401(k) averages book. I hate when someone ruins a book or movie’s ending for me. Soylent Green? It’s people. Sorry about that. In this case, I suspect you’re not planning to order the book (for $95) so I’ll not worry too much about ruining the ending. 1.08%. That’s the total cost for the average large retirement plan, over 1000 participants. For a smaller plan, the average costs rise to 1.24%.

Ideally, your 401(k) helps you to take pretax money, otherwise taxed at say, 25%, and delay the withdrawal until retirement, when you plan to be in a lower bracket, 15%, or so you’d hope. You see what’s happening here? Your goal is to save about 10%, a bit more with the effect of the tax-deferred compounding. It doesn’t take long for a 1% or higher fee to negate this savings completely. Say you are about to receive $1333 in pay. You have two choices, to deposit it pretax in the 401(k) or to pay $333 in tax, netting $1000 and invest that in a Roth IRA. After 20 years of growth at say, 8%, the $1333 grows to $6213 in the 401(k), but a 1% fee reduces this to 7%, returning $5158. Ouch. After 15% tax, you have $4385. In the Roth account, the $1000 grows to $4661.

The 1% is just an example, actual fees run as high as over 2%, a cost I consider criminal. Little wonder that Broker-dealers up in arms 401(k) fee disclosure. You see, there’s a new rule scheduled to take place on April 1, 2012. It requires disclosure of the fees within all 401(k) accounts. Only, this April, the joke will be on us, as the average 401(k) account charges such high fees that most participants should stop depositing after the match, and a good number of plan providers in the 1.5% and above should probably be sued for not offering reasonable investment choices.

Most advisors agree that 4% is the amount you can comfortably withdraw each year from your retirement account. When the fees are 1% per year, there’s 3% for you and 1% for the fat cat on Wall Street who sold this plan to your employer. Me, I’d rather switch than get knocked out, unlike the guy in this classic cigarette ad.

  • Joe P. February 2, 2012, 9:22 am

    This is why (if I remember all this correctly) you should never, ever leave your money in a company 401k when you leave the company. Don’t even roll it into your next job’s 401k; just roll it into an IRA with no fees, little service, and full access to the market. Digging around, the only limitation I could find was that you can only do this every twelve months. The only (theoretical) disadvantage I know of is that you might lose access to an exceptional mutual fund that is only offered by the 401k – but that’s a difficult argument to make in the best of times.

  • JOE February 2, 2012, 9:28 am

    I’ve not heard of any limits on direct transfers, only for taking money (from an IRA) into one’s possession.

    The one issue that comes to mind is if you have any post-tax IRA funds you planned to convert to Roth. Pretax IRA will need to be prorated when you convert. So, if a conversion is planned, I’d do it before transferring the 401(k) into an IRA. My own plan has a remarkably low fee, for most, that’s not the case.

    Thanks for commenting!

  • Elle February 2, 2012, 10:48 am

    Excellent report. I appreciate especially your report on what average 401(k) costs are. The cigarette ad and how you would rather switch than fight is a great final word. 🙂

  • JOE February 2, 2012, 11:50 am

    Much thanks. But just wait till April 1 when the numbers are all required to be clearly disclosed. It only takes one co-worker to pull the numbers are start the discussion. I may be over-reacting here, but I am expecting a bit of an uprising.

  • Steven February 2, 2012, 12:54 pm

    Just to make sure I understand your call to action, are you saying 401k contribution is less valuable in general, or only if your fee is over say 0.5%? I was a little confused because you say you contribute as much as you can to your 401k, but then clearly lay out all the disadvantages caused by a 401k plan’s fees. Would it still make sense to contribute up to the matching max regardless of the fee?

  • JOE February 2, 2012, 1:11 pm

    Contribute to get all matching. Then, consider the fees if you have more you wish to put away.

  • Shaun @ Smart Family Finance February 4, 2012, 10:26 am

    The sad thing is that the additional disclosures ought to be a wake up call for many. However, I doubt most will take notice.

  • JOE February 4, 2012, 11:05 am

    In my day job, unrelated to finance, I am still the guy my co-workers ask about our benefits. I imagine (perhaps incorrectly) that any group of 10 or more is likely to have one individual who pays attention to these things and will discuss with others. If my company 401(k) were expensive, I’d be making a fuss over it.

  • Jon February 6, 2012, 4:56 pm

    @JOE, you’re not over-reacting at all. Most of what will be disclosed will be egregious. My old workplace 401(k) plan options were mostly over half a percent. Hopefully, the April disclosures will cause enough of an uprising that plan providers & administrators will see some considerable pressure to reduce fees.

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